The truth about what happens to credit scores when you need debt help.
Cannot keep up with bills. Need help.
Which option for debt relief hurts my credit the most?
—Concerned about credit score
One of the biggest concerns for people who cannot keep up regular payments on credit card bills while they are researching solutions to get out of debt, is their credit score. The damage to your credit report from chapter 7 bankruptcy, working with a credit counselor to consolidate credit cards, or negotiating debts for less, will vary. How long it takes the credit score to bounce back will vary too.
How important is a good credit score to you right now?
Will a clean credit report give you access to more credit when you are struggling to pay the debts you have now?
Banks and lenders are more risk averse than in years past due to the economy. If your Debt to Income (DTI) shows you are a higher loan risk because you are already carrying too much credit card debt, you will quickly learn that new credit applications will be declined no matter your credit score. In fact, lenders and credit card banks have been cutting the available limits on open credit cards and personal lines of credit down to the amounts currently owed, and even closing unused accounts with customers who have excellent credit reports and higher FICO credit scores. There is more to budgeting for new credit products and maintaining a good credit profile, but for someone struggling to pay bills now; stop thinking about your credit score for the moment. Additional credit products should not be your focus. Dealing with your debt problem and applying the right solution is the priority.
If you’re struggling with debt, whatever the hardship, here is a brief description of what to expect from credit counseling, chapter 7 bankruptcy, debt settlement and chapter 13 bankruptcy and how each impact your credit report and credit score and for how long.
Consolidating your credit cards with a credit counselor.
Your credit cards accepted in the debt consolidation program will be closed. This has a slight impact on your credit score.
While enrolled credit counselors repayment plan it is difficult to get financed for new loans in the first 24 months. This is due to the DMP or similar remark in your credit report, next to each of the debts you enrolled. Debt consolidation with a nonprofit counseling agency typically take 4 to 5 years to complete. You will find you are cut off from new unsecured loans, like credit cards, for most of the time you are with the credit counseling plan.
You may be able to get auto loan, home loan, modify a home loan, or access student loans, for yourself or a cosign for a plus loan, after the first year of successful participation in your debt consolidation plan. When an account in your plan is fully paid, the DMP notation is removed like it never existed. A credit counseling service is a good option if you can swing the lower monthly credit card payment the counselor gets for you.
Credit score, credit report damage and chapter 7 bankruptcy:
Chapter 7 bankruptcy stays on your credit report for 10 years. Just because the you went bankrupt does not mean you cannot get approved for new credit for that whole 10 years. People want to avoid bankruptcy because they want to preserve the credit score by keeping the bankruptcy off the public record section of the credit report. I get it. We are conditioned to build a good credit score our entire adult lives. But, avoiding chapter 7 for a credit score is silly for someone who is unable to keep up with bills. Also, the caution so many people give about getting credit after going bankrupt is plain wrong.
Caution: Having just obtained discharge of unsecured debts in a chapter 7, don’t be in a hurry to obtain fresh debt.
Current FHA underwriting standards mean you will not qualify for FHA home loan funding after filing chapter 7 bankruptcy for a period a 2 years.
You probably wont find a lender willing to help you buy a home within 2 years of filing chapter 7 bankruptcy. This is not a big deal considering real estate in most areas of the country will probably remain in a buyers market. You can use the 2 year window as an opportunity to rebuild your credit and save money for a down payment on an affordable home you will be able to find when you are ready.
For those under water on a current home mortgage, Chapter 7 may provide you an opportunity to move on with your financial health by sending the lender the keys to the front door. You may find a more affordable house for rent nearby your current location.Renting a home for less than your underwater mortgage payment could further provide you the ability to build up savings rapidly.
Student loans may not be approved for a few years after a chapter 7 bankruptcy, including ones you would apply for in order to help a child attend college (plus loans).
You may get approved for an auto loan shortly after a chapter 7 filing. The interest rates on a car loan will be higher for the first year or two outside of bankruptcy.
Credit scores are factored using many data points. About a third of your score is reportedly factored on utilization/debt to income (DTI). Once you discharge debts with a chapter 7 bankruptcy, you will have a healthier debt to income and lower credit utilization. At this point you can begin to restore credit using secured credit cards and credit building unsecured cards that are available. Next you wait out the 2-3 year standard many underwriters use to approve home and student loans after a bankruptcy, and you find that “bankruptcy ruins your credit for 10 years” is a misconception based on the fact that the bankruptcy will stay on your credit report for that period of time.
Chapter 13 bankruptcy, your credit score rating and new credit limitations.
Chapter 13 differs from a Chapter 7 in many ways, not the least of which is how a 13 filing will impact your credit score. In a chapter 13, the bankruptcy trustee will oversee a repayment plan of 3 or 5 years. The chapter 13 will stay on your credit report for 7 years. You will be on a court approved household budget during the repayment plan. If you want to establish new credit you will need to first get bankruptcy trustees approval. The trustee can, and often will, tell you “NO”. Chapter 13 is a credit killer, but you can recover and rebuild credit after you complete the bankruptcy plan.
The majority of chapter 13 bankruptcy plans are not completed. The main reason is that the plans are rigid and inflexible. You do have the courts protection from your creditors, which prevents anyone from suing you. Chapter 13 filings have become a significant tool for home owners to cram down 2nd mortgages which can help prevent foreclosure and the loss of a home.
Debt Settlement credit report damage and your credit score.
Negotiating and settling credit card debts for less than the current balance owed will nearly always require you to be behind with payments. Another major calculation that goes into factoring your credit score is how well you have kept up on time payments on your debt. Since debt settlement typically does not occur until you are at least 90 days behind (most of the better settlement offers wont happen until you are 5 or more months behind), your credit report and score be thrashed. How long the thrashing and credit score pain lasts will be different for each person. Once you achieve settlement on all of your delinquent accounts, your credit score will begin to improve. How long it will take your credit score to improve after debt settlement will depend.
- How long you went delinquent before a zero balance was reported.
- Was the account charged off (settling debt inside of 6 months delinquency is optimal).
- Was it sold after charge off and re-reported (original creditor reports the charge off and the debt collector reports as well).
- What accounts were current during the settlement process (mortgage, car payment, other).
- What was the depth of your positive credit history (have you had cars, mortgages etc… paid off in the past).
- Did you take prudent steps to rebuild credit along the way.
My experience has shown that roughly 18 months after completing the last settlement, and the zero balance due reporting that should be accurately reflected for each account you settled, you’re in decent credit shape again.
I have worked with people who qualified for a loan on a new home 9 months after finishing their settlements (by focusing on the above 6 items) . The primary reason for this is that your debt to income is in better shape, and the math shows you can comfortably service the mortgage.
Summary of credit report impacts.
These 3 solutions are what you may find you are limited to comparing if you cannot afford your debt. The fact is, each of them is going to hurt your credit score. Your credit will remain impaired even if you keep on struggling to meet your minimum payments each month. Your current debt load will keep you from obtaining new credit based on debt balances that are too high compared to your income, even with a high credit rating.
Making decisions on how to deal with your mounting debts should focus on the relief that fits your needs and goals and that you can afford. Placing too high an importance on a credit score that, for all intents and purposes cannot even be used is, in a word – futile.
The above 3 solutions actually compare well when you consider how and when each will put you in position to obtain a student, auto, or home loan.
Get out of debt first, Credit scores can be built back up.
Chapter 7 bankruptcy for provide the quickest and least costly debt relief for most people who can qualify.
Other than discharging debts in chapter 7, my experience helping people resolve debt suggests they next compare a credit counseling services with debt settlement. Make a logical decision based on which option you can afford. A debt management plan would require a monthly payment between 1.8 and 2.2% of your combined unsecured debts enrolled in the plan. If you cannot afford the lower monthly payment the credit counselor quotes you, then look at settling credit card debts.
If you want to learn more about how debt settlement can help you avoid chapter 7, or you need an alternative to chapter 13 bankruptcy, consider contacting a professional for a no obligation consult.
Anyone with questions or concerns about your credit scores and how your choice for debt relief can damage your reports is welcome to post in the comments below for feedback.