how does bankruptcy affect your credit

Fact or Fiction: How Bankruptcy Affects Credit Score

  • By Leigh C. Taylor, LIT

How does bankruptcy affect your credit?

Beyond asset loss, the biggest fear most Canadians have about filing personal bankruptcy is what it will do to their credit rating. Let’s take a moment to separate the fact from the fiction when it comes to your credit history and personal bankruptcy.

Fact or Fiction: Filing for bankruptcy is the only thing that will ruin your credit.

FACT—Many Canadians who are deep in debt fail to realize their overall credit score and the credit rating on each of their accounts may already be very low before they even consider filing for personal bankruptcy. Chances are, if you’re considering bankruptcy, you’ve been struggling financially and your pre-bankruptcy score is likely already too low to qualify for new credit. You may have missed payments, failed to pay the full minimum, or simply been late in making payments on any of your debts — utilities, mortgage, credit cards. Any of those missed or late payments have already had a detrimental effect on your credit rating. If your home is in foreclosure, or if someone has a judgement against you, your credit rating is already at the lowest level it can get to.

Fact or Fiction: Personal bankruptcy destroys your credit score forever.

FICTION – While you are in formal bankruptcy, your credit score is definitely negatively affected in the sense you cannot apply for new credit during the bankruptcy period. However, all Canadians successfully discharged from bankruptcy can begin to rebuild their credit ratings immediately. By employing a few tactics for credit rebuilding, such as opening a secured credit card, it is possible to improve your credit history in as little as twelve to eighteen months. If you retained your home and continued mortgage payments during the bankruptcy, that will have given you a head start on rebuilding your credit rating.

Fact or Fiction: You cannot begin to apply for new credit for six years after a bankruptcy discharge.

FICTION – This is another myth. A debt collector phone call is sure to include the statement that bankruptcy will destroy your credit rating and forget to mention the destruction is temporary. A notation of bankruptcy will remain on your credit report for six to seven years, but you can actually begin rebuilding your credit immediately upon discharge.

Many creditors will consider you less of a risk to lend money to after the bankruptcy than before. That is because, before the bankruptcy, you were burdened with an unsustainable amount of debt — clearly a high risk for a lender. After the bankruptcy, your debt has been wiped out, and, all other things being equal (you are employed, have a steady income) you are now a much lower risk to the lender and more likely to be able to borrow. This is particularly true if borrowing to purchase an asset on which they can take security — a car or a home. It is even more true if you have saved up a downpayment. The ability to manage your finances so that you have saved a portion of the cost of the purchase is a very good indicator to lenders that you have solved your problem with debt.

Saving for a downpayment of any kind is likely impossible when you are burdened with a heavy debt load. However, it will be much easier when you are not trying to pay that debt. There will be some monthly payments required during the period of the bankruptcy, but those payments are based on your ability to pay, not what you owe. The Canadian government sets standards — what they have determined a family of a particular size needs to live adequately. Any income you have during the bankruptcy that is in excess of the standard for a family your size is considered “excess income”. You would be required to pay 50% of the excess income to your Trustee for the benefit of our creditors. The remaining 50% is yours to keep. If you start your savings plan during the actual bankruptcy, you could be well on your way to purchasing that car or house when you are discharged 9 or 21 months later.

Fact or Fiction: Personal bankruptcy is harder on your credit score than non-bankruptcy options.

PART FACT/PART FICTION – When you declare personal bankruptcy each of your credit accounts gets an R9 rating, the worst there is. With a non-bankruptcy option like a Consumer Proposal, your accounts also get an R9 during the course of the proposal. When the proposal is completed successfully, that rating is reduced to an R7 rating.

Also, you need to weigh the fact that bankruptcy will only last between 9 and 21 months. Most proposals last between 3 and 5 years. The rating would not change until after that time period. A bankruptcy will be over more quickly, let you start to rebuild your credit sooner, and generally costs less than a proposal.

While it is true that an R9 is worse than an R7, the practical impact of both is the same – you cannot get credit until you successfully complete whatever program you are in.

Fact or Fiction: Staying debt-free after filing personal bankruptcy improves your credit score.

FICTION: There is a common misunderstanding among many Canadians that you can improve your credit score by not using credit. The exact opposite is true. Once you are discharged from personal bankruptcy, your prior credit history is essentially wiped out. In some ways, you become like the recent college graduate who has never borrowed a dime.

When you emerge from bankruptcy, you will be debt-free. If you choose not to try to get new credit, your credit score will not improve. The only way to improve the score is to get credit and establish a history of on-time repayment.

If you are thinking about declaring personal bankruptcy in Canada, you need to know the facts about what will happen to your credit score. First, you should get a copy of your credit report and see what your current score is. For many Canadians, their current situation has driven their scores so low, getting out of debt as quickly as possible and starting over is their best chance at rebuilding their ability to get credit.

Leigh C. Taylor, LIT

Leigh has been working in the insolvency field since 1975. He is a graduate of the University of Manitoba. Leigh began his career as an Official Receiver with the Office of the Superintendent of Bankruptcy. He is a Certified Professional Accountant, and he attained his license as a Licensed Insolven Read More Leigh has been working in the insolvency field since 1975. He is a graduate of the University of Manitoba. Leigh began his career as an Official Receiver with the Office of the Superintendent of Bankruptcy. He is a Certified Professional Accountant, and he attained his license as a Licensed Insolvency Trustee in 1980. Leigh has been a member of the Canadian Association of Insolvency and Restructuring Professionals (CAIRP) since its inception. He is a Past President of several organizations, including the Manitoba Association of Insolvency and Restructuring Professionals (MAIRP), the Armstrong Point’s Association, and the Manitoba Opera. In addition, he has served for numerous years in leadership roles in Winnipeg churches. Close

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