When bankruptcy is the best option

Bankruptcy is not the end of the world. It can even be good for you.

bankruptcy stops debt collection, lawsuits and garnishment of wages. It erases debt. And despite what you’ve heard, bankruptcy can help your credit score.

Credit bureaus and scoring experts often say that bankruptcy is the worst thing you can do to your results. Foreclosures, repossessions, write-offs, collections – nothing else can drive your results down as quickly and as far as bankruptcy.

But that’s not the whole story. Most people struggle with their debts for so long that by the time they file for bankruptcy, their creditworthiness is already in poor health. And when they do, their values ​​usually go up, not down. When the debt is cleared – what is known as “discharge” in bankruptcy courts – the values ​​rise even more.

“You’ll be much better in a year,” says Jaromir Nosal, assistant professor of economics at Boston College, who did a study for the Federal Reserve Bank of New York about the consequences of bankruptcy. “It’s a pretty quick recovery rate.”

It is a debt-wiping time

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How much and how quickly creditworthiness can increase

  • The average credit score for someone who submitted an application Chapter 7, the most common type of bankruptcy, in 2010 was 538.2 in the 280 to 850 range by Equifax. (Scores in the lower range of 600 and below are generally considered poor.) When applicants’ cases were dismissed, usually within six months, their average score was 620.3.

  • The other kind of bankruptcy Chapter 13, requires a three to five year repayment plan that most people don’t complete. (Half of the Chapter 13 filings between 2007 and 2013 were dismissed, and another 12 percent were turned into Chapter 7 or other types of bankruptcies, according to an analysis by the American Bankruptcy Institute of the Department of Justice’s numbers.) Those who did and a dismissal However, their values ​​rose from 535.2 to 610.8, the Philadelphia Fed researchers found.

A recent study by FICO, the company that created the leading credit rating, found much lower profits. The average creditworthiness of people who filed for bankruptcy between October 2009 and October 2010 rose from the 550s before filing to the 560s after, says Ethan Dornhelm, senior director of FICO’s Scores and Analytics Group. (Most FICO results are on a scale from 300 to 850.)

After two years, 28% of bankruptcy applicants had a score of 620 or more. After four years, 48% had values ​​of 620 or more and only 1% of 700 or more.

But the FICO study made no distinction between Chapter 7 and Chapter 13, or between people who were laid off and those who were not. Those with unsettled debts could skew results. In other words, people with closed bankruptcies could have achieved greater profits than is reflected in the median numbers, says Dornhelm.

Saving your credit score is only one reason

Of course, credit scores aren’t the only factor to consider. Some of the others:

An end to the collective hell: Nosal’s study found that once people were seriously behind on their debts – for example, with at least one account 120 days overdue – their financial problems were more likely to worsen. The balances in the collections and the percentage of people with court judgments grew.

In contrast, individuals who file for bankruptcy benefit from their “automatic stay” which stops almost all debt collection efforts, including lawsuits and garnishments. When the underlying debt is cleared, the lawsuits and the attachment end.

Freedom from certain debts: Chapter 7 bankruptcy wipes out many types of debt, including:

  • Civil judgments (excluding fraud).

Some debts, including child support and recurring tax debts, cannot be paid in bankruptcy. Debt for student loans can be, but it is very rare. But when your toughest debts can’t be paid, clearing other debts could give you the space you need to pay back the leftovers.

Better access to credit: Getting a loan right after a bankruptcy can be difficult. However, Nosal’s study shows that people who have completed a bankruptcy are more likely to receive new lines of credit within 18 months than people who were simultaneously 120 days or more overdue but did not apply.

However, your post bankruptcy credit limits are likely to be low and your access to credit – like your creditworthiness – will not fully recover until a Chapter 7 bankruptcy drops your credit reports after 10 years.

It’s been a long time in the box. But let’s get rid of the notion that people facing bankruptcy are choosing whether to pay their bills or not to pay their bills.

When to stop digging a hole that you can’t escape

Most of us feel that we are one moral obligation to pay what we owe – if we can. But usually that ship left when people realize they need to consider bankruptcy. They can keep trying to reduce debts they may never be able to repay, thereby prolonging the damage to their creditworthiness and diverting money that they could use for a living. Or they can spot an impossible situation, deal with it, and move on.

Of course, if you can pay your bills, you should. If you’re struggling, check your options for Debt relief. But bankruptcy may be the best option if your consumer debt – the types listed above that can be paid off – is more than half of your income, or if even with extreme austerity it would take you five or more years to pay off that debt .

Here’s what you need to know:

You need a bankruptcy attorney: It’s easy to make a mistake in the complicated paperwork, and one mistake can result in your case being dismissed. If that happens, you have no relief – but you still have the credit that has been used up by filing for bankruptcy.

Lawyers typically want to be prepaid: There are some legal assistance and pro bono services available, but they are often overwhelmed by the demand. Once you are really buckled up, call the bankruptcy court near you to find out what resources are available. Your local bar association may be able to refer you to attorneys willing to take on some pro bono cases. Otherwise, you’ll have to scrape up some money.

Collect money the smart way: Cut down on unnecessary expenses if you still have some. Sell ​​things when you have something to sell. If you’re still paying your credit cards and other consumer debts, you can stop and redirect the money to pay an attorney. Another option is borrowing from friends and family. However, do not open new credit accounts to borrow the money as this could be viewed as a scam. Second employment can be problematic if you are growing your income above the median for your region as it makes your filing difficult. Discuss your options with an attorney; many offer a free or inexpensive initial consultation.

Do not wait too long: There is a misconception that people file for bankruptcy in the blink of an eye or when they have other options. The reality is very different for most of them. Some are depriving of assets, such as their retirement accounts, that could have been protected from bankruptcy creditors. People throw good money after bad money until they run out of money to seek help.

That is why we advise debtors to investigate bankruptcy first.

“The worst that can happen is not to go broke and not be able to pay,” says Nosal. “Then people really suffer.”

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