Bankruptcy and The Dangers It Poses to Credit Scores

Debt can start to take a hold on someone's financial standing if they are not careful. Consumers may believe that filing for bankruptcy is a quick fix to this problem, but experts say that doing so will have drastic effects on someone's finances and credit score.

We sat down with one of these experts to discuss bankruptcy and the dangers it can have on credit.

Mark Andrus is an associate attorney for Lexington Law. He graduated from Santa Clara University School of Law, and his practice deals with financial topics such as credit repair law, bankruptcy and general litigation.

Q: Can you explain how the bankruptcy process works?

A: The process commences when a debtor files a petition for bankruptcy with the bankruptcy court. The court then assigns a trustee to manage the estate of the debtor. Within a month or two of filing the petition, the debtor has a meeting of the creditors to answer questions under oath from creditors and/or the trustee. Assuming that the debtor has fully disclosed his assets and liabilities, the trustee will distribute any nonexempt assets to creditors and request that the court grant the debtor a discharge. Upon completing a financial management course, the debtor will receive a discharge.

Q: What are the most common reasons why people file for this process?

A. The most common reasons for declaring bankruptcy are: medical expenses, unemployment, divorce/separation.

Q: Do consumers see bankruptcy as a quick fix to their finances? If so, can you explain the dangers of this mindset?

A: Some consumers are misled to believe that bankruptcy is a quick fix to economic challenges. While bankruptcy does offer immediate relief from qualified debt collection efforts, it may have serious negative consequences. The dangers of the bankruptcy-as-panacea mentality generally lie in collateral consequences such as: damage to credit scores, general loss of access to credit, and difficulty in procuring employment in certain professions (i.e., financial industry, military, etc.).

Q: Do consumers need to consult with someone (lender, accountant) before they begin the bankruptcy process?

A: Yes, consumers may think that they know all about bankruptcy after reading a blog or reading a do-it-yourself book, but many consumers fail to understand the powers granted to the bankruptcy trustee. Immediately upon filing for bankruptcy, the consumer generally cedes all power over their property and estate to the trustee including prior transfers of property for up to four years.

Q: How long is bankruptcy on a credit report?

A: Under the Fair Credit Reporting Act, a negative credit item regarding a bankruptcy may remain on a consumer's credit report for up to 10 years. Generally, however, the 10 year limit applies to Chapter 7 bankruptcies. It is also important to distinguish that items included in bankruptcy may only remain on a consumer's credit report for up to seven years from the initial date of default; not seven years from the filing of the bankruptcy.

Q: How drastic will a bankruptcy filing impact a credit score?

A: Negative items regarding bankruptcies are among the most damaging to a consumer's credit score.

Q: How can consumers repair their credit after filing for bankruptcy?

A: It is imperative to remember that credit repair is a process and one that requires time. Consumers should avoid applying for credit with more than two or three new creditors per year as even attempting to procure credit can negatively affect a consumer's credit score. Ultimately, Lexington Law Firm is dedicated to credit repair and consumers in need of credit repair should call for a free consultation.

Q: Can you file for bankruptcy more than once? Are there any drastic effects when that occurs?

A: If a debtor receives a discharge under a chapter 7 bankruptcy then he may not file another chapter 7 bankruptcy for eight years. The debtor may, however, file a chapter 13 after four years of a discharged Chapter 7 bankruptcy with a court-approved plan. Meanwhile, successive chapter 13 petitions may be filed after two years of the prior discharge with a court-approved plan. The negative effects are generally a prolonged period of recovery (i.e., up to 20 years with a bankruptcy item on the debtor's credit reports), damage to reputation, and loss of available credit.