Life after bankruptcy: misconceptions can cause confusion

May 4th, 2010 by Mike Hinshaw

Last time we looked at reaction to the “moral failings” argument of critics opposed to people filing for bankruptcy protection. Besides the idea that bankruptcy is how deadbeats game the system, we often hear dire warnings such as, “You’ll ruin your credit score,” or “Bankruptcy stays on your record for ten years,” or “You’ll never get a decent job again.”

Quite often, the people or companies using these scare tactics are pitching products or programs of their own. If you read something along the lines of bankruptcy will “ruin your life,” be sure to investigate what course of action or product is being offered as an alternative to bankruptcy. (As we’ve noted before, be particularly wary of so-called “debt settlement” companies that offer the moon while demonizing the bankruptcy process–more about this in Part 2.)

FTC and credit counseling

For instance, legit credit counseling agencies do exist. Here’s the Federal Trade Commission’s page called “Information About Credit Counseling and Debtor Education,” a thorough overview of the credit-counseling aspect of bankruptcy that also includes a link to “list of approved debtor education providers at www.usdoj.gov/ust/eo/bapcpa/ccde/de_approved.htm or at the bankruptcy clerk’s office in your district.” The page also features a good list of crucial questions to ask of any debt counseling agency or service.

One thing that pops out, though, concerns fees and up-front costs: The FTC says the cost for the initial session should “generally be about $50, depending on where you live, the types of services you receive, and other factors.” Furthermore, “If you cannot afford to pay a fee for credit counseling, you should request a fee waiver from the counseling organization before the session begins.”

Now, if counseling or other research indicates that bankruptcy protection is not for you, then don’t pursue it–and certainly don’t use the protection frivolously.

Bankruptcy ruins credit-rating?

That being said, however, many of the horror stories are just that, scary stories that don’t bear up under research. For example, will bankruptcy ruin your credit rating? Unfortunately, that’s not a yes-or-no answer. True, bankruptcy is the single largest hit a credit score can take. Here’s a recent comparison  (not exact, due to the vagaries if the FICO equations) from CNN.Money.com, showing various effects of mortgage delinquency, foreclosure and bankruptcy: clearly, at a range of 130 to 240 points, bankruptcy is a huge hit.

If you’re 30 days late, expect your rating to drop 40 to 110 points; 90 days late, 70 to 135 points–but if you lose your home, it’s somewhere in the 85 to 160 range. And that’s regardless of whether the loss is through foreclosure, short sale or deed-in-lieu.

For a homeowner, the primary concern often becomes the tradeoff between saving the home (usually through Chapter 13 protection) and the lowered credit rating: If losing the home results in major credit-rating downgrade, what’s been accomplished?

Another consideration involves the “weighting” of the FICO analysis. The way it works is someone with a high credit rating has more to lose, according to the CNN piece:

“Some borrowers will fall much more steeply than others for the same payment problem, according to Maxine Sweet, vice president for public education at Experian, one of the nation’s main credit bureaus.

” ‘If you picture someone who has just one mortgage and one other credit account versus a mature credit user like me with 15 accounts, if they miss one payment that would impact their scores a lot more,’ she said. ‘For me, one missed payment would just be a blip.’

“The point loss also depends on the borrower’s starting point: People with very high credit scores have more to lose than low-score borrowers; the impact of a single blemish on an 800 score is more than on a 500.”

This comes into play for many who have been struggling for a long time; that is, their credit ratings may already be in tatters.

Making a business decision

The cold, hard business decision, then, becomes “What’s the best way to start over, and begin rebuilding?”

Again from the CNN article: “Despite the problems a poor credit score can cause, Experian’s Sweet recommends that people who are in financial dead ends, like totally unaffordable mortgages, it’s better to recognize that and cut your losses quickly; don’t prolong the problem.

” ‘You need to do what you need to do to get your finances back in order,’ she said. “Don’t worry about your credit score.”

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If you are overwhelmed by debt, filing for bankruptcy protection may be your most pragmatic alternative. If you are facing foreclosure of your home (sometimes referred to as your “primary residence,” as opposed to a second home, or “vacation home”), bankruptcy protection may be your best route to saving the home. If you are struggling with medical bills, you may be in a special category for setting debt aside, and if you have problems with credit-card debt, please know the laws have changed recently. For bankruptcy basics, please see:

Principles of bankruptcy

Basics of bankruptcy

Introduction to Chapter 7

Introduction to Chapter 13