Bankruptcy's Effect On Credit Score: Lender Rebuts Common Myths

Bankruptcy debtors often worry about the effect of a bankruptcy on their credit rating and their ability to finance new cars and homes after filing bankruptcy. The consensus opinion of my clients is that a Chapter 7 bankruptcy ruins your credit and that a Chapter 13 bankruptcy has less adverse impact on credit. One of my clients this week owns a company that buys automobile finance contracts. This client is not filing bankruptcy. His company purchases debt from other companies making sub-prime auto loans, companies such as buy-here-pay-here lots and payday loan businesses. He says that the debt packages he buys always includes loans made to people with prior bankruptcies. He knows the effect of bankruptcy on credit ratings. He told me there are two prevailing myths about bankruptcy and your credit score.

The first myth is that Chapter 7 bankruptcy always destroys your credit. He says the main credit factor following bankruptcy is the debtor’s debt history just prior to filing bankruptcy. If the debtor files early, when he first anticipates financial problems, the debtor may then be current on all debt accounts. If there are no, or few, delinquencies on the filing date, the bankruptcy will have no adverse effect on credit. In fact, my client said, that the bankruptcy will improve those debtor’s credit ratings because it will improve their income/debt ratios. The client says that debt/income is more important than bankruptcy for credit score. If, as too often happens, debtors avoid bankruptcy until they are seriously delinquent on their debt accounts the bankruptcy will not improve, and may hurt, the debtor’s credit rating. The bankruptcy debtor’s credit will suffer more from pre-filing delinquencies than from the bankruptcy itself. The lesson is to file bankruptcy when your accounts are still current.

The second credit myth is that Chapter 13 has less impact on credit than Chapter 7 because the debtor is repaying some of his debt. My client stated  that lenders are less likely to finance debtors in Chapter 13 because the debtor has not eliminated his debts and usually has still a below standard debt/income ratio. The fact that the Chapter 13 debtor is repaying his debts in the bankruptcy does not convince my client’s lenders to provide preferred financing.

Some callers ask me if they have to be delinquent a specific number of months on their unsecured debt in order to qualify for Chapter 7 bankruptcy. The answer is "no" and based on this client’s experiences in the lending industry the more you wait for bankruptcy the worse is its impact on credit.

Comments

[m mccullough]

What if I own an LLc that is owed money and slowly being paid but all that money needs to go to other companies for payment of services. I am personally in major financial problems and I can't find any new work for my construction business but I need to pay the trades back because if I don't it damage my License. What can I expect? I want to file chapter seven. There is about 5000.00 of profit in the amounts owed and 120,000.00 in payables

[Joseph C. McDaniel]

What a valuable piece of information!

Jonathan, if you get any confirmation at all about this from other sources, PLEASE write more about it!

Poor little debtors ask me what effect an Arizona Chapter 7 bankruptcy is going to have on their credit, and my usual response is simple: a bankruptcy filing will trash your credit, but because of the nine lawsuits, three judgments and a trustee's sale, you have little credit to trash.

If there's any way to substantiate this (and I don't disbelieve your friend, I just like to hear new stuff from multiple sources so I don't get an entire carton of eggs on my face), my advice will change.

Because, of course, many people go talk to an Arizona bankruptcy attorney (or, I'm certain, a Florida bankruptcy attorney) because they're still in denial, but they're kicking the tires of reality. This would be valuable for couples who come in because they're "just checking their options" (you make three thousand a month and your debts currently run at five thousand a month and you've just finished burning through all your retirement funds; which options were you thinking about?).

But this is a great post, and I appreciate it that you took the time out of your copious spare time to share. And, yeah, I was just kidding about the copious spare time. It being a depression and all. And you being a Florida bankruptcy lawyer.