How Filing Bankruptcy Can Improve Your Credit Score
By Veronica Baxter - Bankruptcy Legal Assistant
Last Updated 05/11/2020
Summary: Depending on your situation there are instance where filing for bankruptcy may improve your credit score.
You may have heard that if you file bankruptcy, that fact stays on your credit report for up to ten years. That is true. And yes, there is a negative impact on your credit score in the short term.
What you may not have heard is that if you’ve used a bankruptcy filing to get your unsecured debt discharged, that will improve your credit score.
And, if you’ve used a bankruptcy filing to get caught up on mortgage, rent, car loan, or alimony or child support arrears, this will also improve your credit score.
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If you find yourself behind or just have too much debt that you fear you can never pay, you can resolve this through filing bankruptcy, and your credit score will rise when the bankruptcy case closes.
Here’s how that works.
Filing Chapter 7 Bankruptcy to Discharge Unsecured Debt
What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is a four- to a six-month process by which you disclose all of your income, expenses, assets, and debts to the bankruptcy court and Chapter 7 Trustee, and if you qualify, your unsecured debt is discharged, meaning, you are no longer responsible for paying it.
What is Included in a Chapter 7 Bankruptcy?
Unsecured debt that is dischargeable in Chapter 7 includes:
- Medical bills
- Credit card debt
- Some government fines and fees
- Some income taxes
Unsecured debt that is not dischargeable in Chapter 7 includes:
- Alimony or spousal support
- Child support
- Most income tax
- Student loans
- Fees or fines related to drunk driving or criminal convictions
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How Does Chapter 7 Work?
Before You File Chapter 7: Pre-Petition Requirements
First, you must pass the “means test,” which calculates whether you income-qualify to file under Chapter 7. If you make too much money to file Chapter 7, you can file under Chapter 13 and pay some of your unsecured debt back over the life of your plan.
After you pass the means test, you take what is called a Credit Counseling course, which you can take over the phone or online. You will find a list of authorized providers on your district’s bankruptcy court website.
You must also take a post-petition Financial Management course. Many providers offer this course as well as the pre-petition Credit Counseling course and at a discount, so do your research.
You will prepare a petition setting forth your personal information and schedules disclosing your financial information. These, along with proof of course completion and the filing fee, are submitted to the bankruptcy course electronically.
After You File Chapter 7: Post-Petition Requirements
After you’ve filed your case, you will be assigned a Chapter 7 Trustee and a date for the 341(a) meeting of creditors. You and your attorney will meet with the Trustee, and you will answer the Trustee’s questions under oath.
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Any creditors having questions about or problems with your filing can appear and question you as well. Once the Trustee is satisfied, the meeting closes.
After the deadline for creditors to object to the discharge of your debt has passed, the court will enter a discharge order, and your case will close.
How Will Filing Chapter 7 Bankruptcy Improve My Credit Score?
If you’ve received a discharge of your unsecured debt, your debt-to-income ratio has likely improved significantly.
This is one influential factor in determining your credit score, and while the fact that you filed bankruptcy will still appear on your report, the negative effect your filing had on your score will probably be more than outweighed by the improvement in your debt-to-income ratio.
Filing Chapter 13 to Catch Up on Past-Due Debt
What is Chapter 13?
Unlike Chapter 7, Chapter 13 requires a three- to a five-year repayment plan, and when the plan is complete, you receive a discharge of the remaining unsecured debt that was not repaid.
Many Chapter 13 debtors end up not paying any unsecured debt through their plan because they’ve put attorney’s fees and mortgage arrears or other arrears through their plan and don’t have the income to pay unsecured debt also.
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How Does Chapter 13 Work?
Like Chapter 7, you must take the pre-petition Credit Counseling course and the post-petition Financial Management course.
You also must disclose your income, expenses, assets, and debts in your petition and schedules. You will also attend the 341(a) meeting of creditors.
Unlike Chapter 7, you will file a proposed repayment plan. In this plan, you can repay:
- Alimony arrears
- Child support arrears
- Mortgage or rent arrears
- Car loan or lease arrears
- Federal and state income taxes
- Student loan arrears
At the completion of your plan in three or five years, you will be caught up with whatever account(s) you defaulted.
You will have the remaining unpaid unsecured debt discharged, and unlike Chapter 7, this may include certain income taxes and student loans, under strict circumstances.
How Can Chapter 13 Save Me Money on My Mortgage or Car Loan?
How You Can Strip Off a Lien in Chapter 13
If you have a second mortgage and your home is worth less than the amount that you owe on the first mortgage, you can have the second mortgage stripped off as unsecured and discharged.
This applies also to any liens in excess of the underwater first mortgage, for example, mechanics liens, judgment liens, and home equity lines of credit.
How You Can Cram Down Your Car in Chapter 13
If your car is worth less than what you owe on the loan, you can cram it down to the retail value and pay that off in your Chapter 13 plan subject to interest in the amount of prime plus 1-3%.
At the end of your plan, you will own the car outright!
How Does Chapter 13 Improve My Credit Score?
Like Chapter 7, your debt-to-income ratio will improve because your unsecured debt will be discharged.
Unlike Chapter 7, you will have had the opportunity to catch up on past-due accounts, and you can cram down your car loan or strip off a lien as unsecured, and be discharged of whatever remains unpaid.
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The fact that you are paying your monthly plan payment to the Chapter 13 Trustee will be reported on your credit report and help improve your credit score if you are conscientious about it.
Paying your plan payments and catching up with arrears is the first step in creating a positive credit history - be sure you pay in full and on time!
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Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.