Why it Takes Longer to Restore Your Credit After Bankruptcy Than Debt Settlement

Key Takeaways
  • Missed payments in either bankruptcy or debt settlement will cause a decline in your credit score.
  • Bankruptcy does the most damage to your credit and takes the longest time to recover.
  • Chapter 7 bankruptcy stays on your credit for 10 years.
  • Late payments remain on your credit file for seven years after the first missed payment.

Debt has you overwhelmed. Between large credit card balances and only making the minimum monthly payments, you realize it will take nearly three decades to get rid of your credit card debt. 

And, what about your credit score? Here’s some facts that may surprise you as you make the final decision to move forward with a debt relief strategy

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You may have thought to yourself…

  • If I settle my credit card debt for less than what I owe, will anyone ever lend to me again?
  • If my credit score drops, it may be harder to buy a house or get new lines credit.  

But, consider this! Surprisingly, credit recovery may not be as difficult as you think.   Moreover, re-establishing your credit may take less time and be easier after completing a debt settlement program than it would be after filing for bankruptcy.

The Initial Impact of Late Payments on Credit

Whether you choose to file bankruptcy or enter a debt settlement program, you will face an initial decline in your credit score. However, if you have already struggled with late payments or defaulted on one or more accounts, the decline you see in your credit may not be as significant as it would be if you are making timely payments on all accounts.

Also, carrying high balances relative to your credit limit can also significantly lower your credit score, lessening the initial impact of either bankruptcy or debt settlement.  So, depending on your individual situation, this short term drop in your credit score may turn out to be less of an issue than you imagine.

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Bankruptcy and Your Credit 

Chapter 7 Bankruptcy, assuming you can qualify, can discharge unsecured debts such as credit cards, personal loans, and medical bills. It will not typically help with secured debt, student loans, tax liens, or delinquent child support payments.

In most cases, you include all unsecured debts and close all accounts, in exchange for eliminating your obligation to repay any of the unsecured debts you enroll. 

Bankruptcy may seem like the easy way out; but, it also does the most damage to your credit score and is the debt relief option that has the most lasting impact on your credit and your future ability to obtain new lines of credit. 

Long-term Credit Consequences of Bankruptcy

When working to rehabilitate your credit after filing bankruptcy, Credit Card companies are usually the first to offer new credit, typically in the form of secured debt. You might also get offers for low limit cards with high interest rates and high fees. If you accept these offers, you will need to be pay your balances in full each month, or risk further damager to your credit, or, find yourself quickly back in debt due to the very high interest rates that come with these credit cards.

Home and Auto Finance companies typically will not consider a loan approval until three to five years after the bankruptcy has been discharged.  

Credit Report and Score: A chapter 7 bankruptcy remains on your credit file for ten years. While bankruptcy is not reported on your credit report after 10 years, it is a matter of public record and anyone performing an internet search can easily find the public filing online.  As such, many employers and other credit grantors ask on applications if you have ever filed bankruptcy.  If asked this question, you will need to answer in the affirmative as the evidence of your filing will be available indefinitely.  

Debt Settlement and Your Credit

Debt Settlement involves negotiating a debt payoff of less than the full balance you owe. Companies specializing in debt negotiation often settle all debts within two to four years, depending on the amounts owed and how much you set aside each month for debt reduction.

You have the option to include some or all debts in the program. If you keep one credit account open and make on-time payments, it can speed up credit recovery. On-time mortgage or car payments also help restore your credit faster.  

Long-term Credit Consequences of Debt Settlement

Credit Cards: It is not uncommon to receive credit offers before completing your debt settlement arrangement. Use caution when adding new debt before settling existing balances.  While you may see a short term drop in your credit score shortly after starting a debt settlement program, as you settle debts and your creditors notate the accounts as paid in full, your credit score will start to improve with steady, on-time payments on your other secured accounts.

Home and Auto Finance companies want to see that you have debt under control before approving a new loan. There is no set time before a bank will approve a new loan. The faster you settle existing debts, the sooner you will qualify. The important thing is to make your payments on all accounts that are not enrolled in a debt settlement program and settle all your enrolled debts as quickly as possible.  

Credit Report and Score: Late payments remain on your credit report for seven years or 84 months. The latest FICO 9 score calculation does not consider delinquencies or charged off accounts once you pay the account in full or settle the account for less than the full amount owed and complete the payment arrangement. While the account no longer counts negatively based on the past payment history, you will also lose some positive contributions to your score such as total number of accounts on your credit report and the total length of your credit history. 

How to Improve Your Credit Faster?

Bottom line:  When you settle all your enrolled debts and continue to make your other credit account payments on-time each over the duration of the program, a debt settlement program may restore your credit faster than bankruptcy. Settled debt is not included in the FICO 9 score calculation and is treated as less severe by lenders. You can also speed up credit recovery by having one or more accounts with monthly on-time payments. 

FAQs
  • Is Chapter 13 bankruptcy better than debt settlement?

    Debt settlement allows you to make partial payments on debt. Once you reach an agreement with the creditor, they release you from further liability of any remaining balance. Chapter 13 bankruptcy also requires you to repay a portion of your debt before receiving a discharge. The key difference is that in Chapter 13 the court decides how much you can pay (100% of discretionary income for five years). In debt settlement you pay based on  negotiations with creditors. 

  • Is Chapter 7 bankruptcy better than debt settlement?

    If you cannot make any payments on your outstanding debts, Chapter 7 bankruptcy may be the best option, if you qualify.  If you do not qualify for Chapter 7, you are required to file Chapter 13 if you want to go the bankruptcy route. Chapter 13 requires you to repay creditors under court supervision for five years. Debt settlement provides help by negotiating balances with creditors, allowing you to pay less than the full amount owed without interference from the court system.