Any bankruptcy lawyer will tell you that the number one concern people have when filing bankruptcy is “damage to their credit.”
There are plenty of misconceptions, myths and flat out lies circling the various media outlets about how bankruptcy should be a last resort and how it will destroy your credit. I would argue that neither of these statements is true.
Unfortunately, as a society, we have become unreasonably obsessed with our credit score.
Your FICO (Fair Isaac Corporation) score is a systematic number that in many cases does not indicate your ability to repay debt. It is not always an accurate indicator of your creditworthiness.
As Investopedia explains, the FICO score is based on five factors: (1) payment history; (2) current level of indebtedness; (3) types of credit used; (4) length of credit history; and (5) new credit.
As you can see from these factors, you need to use credit in order to improve your credit and this opens you up to risk.
Regardless, why do we have this irrational fear of FICO?
My Confusing Consultation
A few weeks back, I met with a woman for a bankruptcy consultation. Right from the beginning of our meeting, she made it clear that she was very wary of the bankruptcy process and what it would do to her credit.
That’s fair.
The further along we got into the consultation, the more I realized how irrational this fear was.
This woman’s home was in foreclosure as she had been unable to pay her mortgage for over 24 months due to loss of employment.
Her unsecured debt totalled more than $30,000 and she had no steady income.
Most of her accounts were in collections and she indicated that she already had two judgements entered against her.
Here was somebody whose credit was already destroyed.
I informed her that she had no way of repaying this debt, that the situation would continue to spiral out of control and the only way to get on the path to financial recovery was to file bankruptcy.
I told her that the bankruptcy would actually rehabilitate her finances and improve her credit. For some, this is hard to fathom.
As suspected, I received a call from this woman just the other day indicating that after discussing the matter with family, she would not be going forward with bankruptcy.
File Bankruptcy and Fix Your FICO
When the financial situation is dire, sometimes the only way to improve your credit is to file bankruptcy.
High balances, delinquent accounts and late payments are all completely removed from your credit report allowing you to start from scratch and rebuild your credit. In addition, with no debt, you are less of a credit risk to potential lenders.
By erasing all of your debt, bankruptcy will improve your debt to income ratio, one of the main factors in determining your FICO score. Bankruptcy can increase your credit score as evidenced below.
So, if you are considering bankruptcy, your credit is probably already damaged or on the verge of being damaged. Do not let an irrational fear dissuade you from fixing your finances and your future.
Image courtesy of mrpattersonsir (Flickr).