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Will Chapter 7 Bankruptcy Lower My Credit Score?

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In a Nutshell

Most people who have low credit scores and file for bankruptcy actually see their credit scores improve.

Written by Attorney Jonathan Petts.  
Updated August 27, 2021


One of the biggest reasons people in the United States don't file for bankruptcy is that they’re afraid it will lower their credit score. But most people who have low credit scores and file for bankruptcy actually see their credit scores improve. A low credit score here refers to credit scores that are under 600. If you fit this credit profile, it’s also more likely you’ll have access to one or more lines of credit in the year following your bankruptcy.

Bankruptcy Can Actually Help Your Credit

A study by the New York Federal Reserve shows that bankruptcy can actually help your credit. Here are some notable findings:

  • One year after filing, people who filed for bankruptcy opened up more unsecured accounts than people in the same financial situation who chose not to file. More than half (55%) of people who file for bankruptcy have new lines of credit one year after filing. Compare this with 30% of people in the same financial situation who choose not to file.

  • One quarter after they filed bankruptcy, individuals who filed bankruptcy had considerably higher credit scores than those who were newly insolvent who didn't file. The same was true four quarters, or one year, after filing bankruptcy. Individuals are considered insolvent when their debts exceed their assets.

  • Within one quarter of filing for bankruptcy, filers' credit scores improved by an average of 80 points over people in the same situation who didn't file. This difference is 60 points after four quarters.

As you can see, most bankruptcy filers' credit situations improve as time passes. This is true even in a relatively short period of time (one calendar quarter is four months). Having a higher credit score means that you'll save money in the long run because you won't have to use alternative loan companies, like payday lenders or expensive personal loans. How much does good credit pay? One study showed that a 100 point loss in your credit score can cost you $200,000 over the course of your lifetime.

How Does Bankruptcy Help Improve My Credit Score?

You may be wondering how filing for bankruptcy can increase your credit score if you have a credit score that is less than 600. There are a few reasons. First, wiping your slate clean makes creditors realize that you’re more likely to pay them back. Just think of two different people, John and Sam. John is $40,000 in debt and owes three hospitals, four credit card companies, and five friends money. Sam, on the other hand, just filed for bankruptcy so he does not owe anybody.

Who are you more likely to give a loan to because you think they’ll pay you back? If you give a loan to Sam, you are going to be the 13th creditor that he owes. If you give a loan to John, you are going to be the only creditor that he owes. Of course, you are more likely to give the loan to John, even if he just filed for bankruptcy. The takeaway is that lenders look at your credit score to determine how risky you are as a borrower and how likely they are to lend you money.

Another reason that people with low credit scores who file for bankruptcy see their credit scores increase after they file is that you can only file for bankruptcy every eight years. Credit card companies are afraid to lend to people who have a lot of debt and low credit scores because they are afraid the person will declare bankruptcy and erase their debt. But credit card companies are not afraid that people who just filed for bankruptcy are going to file for bankruptcy again anytime soon because it's not possible. On the other hand, people who haven't filed and have high debt levels still have the ability to.

How Can I Improve My Credit Score After Bankruptcy?

There are several deliberate steps that you can take to improve your credit score after bankruptcy. As long as you’re thoughtful about your finances after bankruptcy, you should be able to access new credit in a timely manner.

Unfortunately, despite the data behind the benefits of bankruptcy, many low-income Americans are still afraid to file due to misinformation. As a result, people who decide not to file even though it would improve their credit scores end up having difficulty getting credit cards and bank accounts. In many cases, they continue to deal with wage garnishment and have a tough time finding jobs.

We encourage you to take a look at the data and decide for yourself whether you believe bankruptcy will improve your financial situation. You can find more information in our Learning Center, file Chapter 7 bankruptcy for free with our online filing tool, or get advice from an experienced bankruptcy lawyer.

Upsolve Co-Founder Jonathan Petts explains bankruptcy basics in the video below ⬇️



Written By:

Attorney Jonathan Petts

LinkedIn

Jonathan Petts has over 10 years of experience in bankruptcy and is co-founder and Board Chair of Upsolve. Attorney Petts has an LLM in Bankruptcy from St. John's University, clerked for two federal bankruptcy judges, and worked at two top New York City law firms specializing in... read more about Attorney Jonathan Petts

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    Upsolve is a 501(c)(3) nonprofit that started in 2016. Our mission is to help low-income families who cannot afford lawyers file bankruptcy for free, using an online web app. Spun out of Harvard Law School, our team includes lawyers, engineers, and judges. We have world-class funders that include the U.S. government, former Google CEO Eric Schmidt, and leading foundations. It's one of the greatest civil rights injustices of our time that low-income families can’t access their basic rights when they can’t afford to pay for help. Combining direct services and advocacy, we’re fighting this injustice.

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