Monday, February 8, 2010
How Does Bankruptcy Affect My Credit?
Bankruptcy and its affect on credit is unquestionably the biggest concern of most bankruptcy clients. The ironic aspect is that often bankruptcy, especially Chapter 7 bankruptcy, is the quickest road to credit recovery.
Everyone knows that credit score dictates a person’s ability to borrow. What many people do not realize is that credit score is only one element of lending criteria.
Lenders will tell you that credit score will “open the door” to getting a loan, but the single most important lending criteria is DTI, or, debt to income ratio.
DTI, in basic terms, is the percentage of a person’s monthly gross income that is utilized to pay their debts. If a person’s DTI is too high, that too much of their income is used to service debt, lenders will be very reluctant to continue to lend money.
Again, the irony of credit is that a person can have a credit score of 750 (which is excellent and would indicate a good potential borrower) but will be denied a loan because their high DTI ratio. For example,
Bob has a FICO credit score of 750 and DTI ratio of 85%. Bob wants to borrow money to purchase a vehicle. While Bob will be “pre-approved” based on credit score alone, the vehicle lender will likely decline Bob’s loan. Based on Bob’s DTI, the lender is concerned that Bob cannot continue to service his debts and will therefore be a substantial default risk.
I use the term ironic in describing credit because credit score is very often just a façade. While Bob’s score is high, it is still somewhat worthless – really no different than a person with a 550 credit score. Why? NEITHER CAN BORROW MONEY!!
Bankruptcy is often a very quick credit recovery because a person’s DTI is instantly and substantially reduced through the bankruptcy. Bankruptcy discharges the debt – instantly improving the DTI ratio, which again, are the single most important criteria evaluated by lenders when taking loan applications.
Christopher W. Boss, Esq.
Yesner & Boss, P.L.