Have you heard that bankruptcy will ruin your credit for 10 years? This is a common misconception. The correct information is that the notation of bankruptcy may stay on your credit report for up to 10 years, but your credit score will not suffer that entire time because of it.
In fact, in many cases bankruptcy can help improve your credit score faster than paying off a large amount of credit card debt over time or settling accounts one by one.
Filing bankruptcy can cause your credit score to drop 100 to 200 points right away, depending on what your score was prior to filing.
However, after about a year from filing bankruptcy, even without doing a thing to “rebuild” your credit, your credit score will increase on its own. After two years, it should be back up to pre-bankruptcy numbers, if not higher.
How can bankruptcy be better for your credit score than paying or settling debt? Your credit score is produced by a formula of many different factors. Debt-to-income ratio is a large factor, as are recent delinquencies.
When you settle accounts, you would think this would have a positive impact on your credit score. However, there is some bad with the good, because the account entry will contain a notation that it was settled for less than full payment.
When people are working to settle accounts, typically they are putting the money together by going delinquent on several other accounts. These delinquencies further decrease your credit score.
If you have a large amount of unsecured debt, such as credit cards, your credit score is likely not as high as it could be due to the debt-to-income ratio part of the formula.
If you have been more than 30 days late on any of these unsecured accounts, your credit score is severely impacted. In this case bankruptcy can improve your credit score faster than paying off all of the credit card debt over a long period of time because your debt to income ratio looks much better almost instantly.
Bankruptcy is not the best option in every scenario. It is important to look at the big picture when analyzing your options with regard to debt, which means comparing income to expenses, debt to assets, and weighing the pros and cons of each option.
When debt becomes overwhelming to the point of making it difficult to decide whether to pay credit cards or the mortgage, that is a good time to consult with an attorney or financial planner to become more educated on the different alternatives available to you.
• Denise K. Aguilar is an Ahwatukee Foothills resident and attorney whose practice focuses in consumer bankruptcy. Reach her at (480) 455-1881 or www.aguilarlawonline.com.