How Can Bankruptcy Be Damaging to Credit?
Bankruptcy has the single worst effect on your credit score of all possible blemishes. Part of the reason for this is that you are granted a discharge of all of your debts, often without having to pay anything to your creditors. Bankruptcy affects many of the key metrics of your credit score, including the duration of your credit history, the amount of your available credit and your payment history.
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Duration
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One of the reasons bankruptcy can be so damaging to a credit report is that it stays on the credit report longer than any other delinquency. A Chapter 13 bankruptcy will appear on your report for seven years, while a Chapter 7 bankruptcy will remain for a full 10 years. During that time, any creditor that looks at your report will see that you filed bankruptcy, making it tough to receive any loans that do not come with very high interest rates.
Payment History
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Once you file bankruptcy, your payment history effectively vanishes. Even if you made on-time payments for years, the most recent entries will show that you simply stopped paying all of your debts. While late payments have a negative effect on your credit, not paying at all and effectively walking away from your debt has a major negative effect. According to the Fair Isaac Corporation, originators of the FICO credit score, your payment history is the single largest contributor to your credit score. Since you stopped paying all of your creditors when you filed bankruptcy, effectively 35 percent of your account immediately dropped to negative status, creating a major drag on your total score.
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Length of Credit History
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Another important component of the FICO credit score is length of credit history, counting for 15 percent of your total credit score. When you file bankruptcy, your creditors will typically close all of your credit accounts. As a result, the length of your credit history effectively drops to zero when you file bankruptcy. Combine this with the 35 percent weight of your payment history, and now a full 50 percent of your credit score is at the lowest possible level, greatly affecting your overall score.
Types of Credit Used
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When your creditors close your accounts after you file bankruptcy, you also lose the benefit of having different types of credit lines open and in use. While the types of credit used is only 10 percent of your FICO score, it acts as another drag on your total score when your credit lines all close. You can help this part of your score by continuing to pay any installment accounts you can afford to keep through bankruptcy, such as your home mortgage or car payment.
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