Most people feel a moral obligation to pay their debts and refuse to consider bankruptcy as an option even when their credit is severely damaged. However, in many cases, the reason people get into financial trouble is beyond their control, such as incurring massive medical debt.
Bankruptcy can often be the best option available, especially when it stops annoying and threatening bill collectors from calling, protects people against lawsuits and even keeps creditors from garnishing their wages.
How soon can a credit score rebound?
A study by the Federal Reserve Bank of Philadelphia found credit scores plummeted for bankruptcy filers in the 18 months prior to filing, but most rose steadily after taking action. On average, those filing for Chapter 7 saw their scores rise from 538 to 620 within six months.
A more recent study by FICO found it took longer for scores to rebound – most with scores from 550 to 560 before filing saw it take at least two years to reach 620 and above. However, the FICO study didn’t differentiate between Chapter 7 and Chapter 13 filings.
Bankruptcy brings other benefits
But restoring a credit score is only part of the reason to consider bankruptcy. Others are:
Ending collection nightmares: The Federal Reserve study saw financial difficulties get much worse for people who fell 120 days behind on payments leading to increased court judgments against them. Filing for bankruptcy gives people an automatic stay from all collection efforts, wage garnishment and lawsuits.
Wiping out certain debts: Chapter 7 bankruptcy frees people from many types of financial liabilities, such as:
- Medical bills
- Credit card debt
- Personal loans
- Civil judgments, except for fraud
- Unpaid rent
- Past-due utility bills
- Business debts
- Older tax balances
Renewed access to credit: While it can be challenging to get credit immediately after filing for bankruptcy, the Fed study showed those who completed the process were more likely to receive new lines of credit within 18 months than those who fell 120 days or more behind on their payments. Although, credit limits are likely to be low at first and a Chapter 7 filing won’t completely drop off your credit report for 10 years.
Bankruptcy is one of many options for debt relief
Many people try to make sustained progress in paying down their debt, and if they can make on-time payments, that can be the best strategy. However, when they reach a point where their debt equals more than half of their yearly income, or it would take five years or more to pay off balances, bankruptcy may make the most sense.
If you are overwhelmed by massive debt and are considering filing for Chapter 7 or Chapter 13, it’s essential to talk to an experienced bankruptcy attorney who understands the complicated process and will help you choose the best path back to financial freedom.