The Scarlet Letter “B”:  Why filing for Bankruptcy is not the death knell that some people think that it is.

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As the Covid-19 moratoriums on collections, evictions, foreclosures, and lawsuits are all going away, people are starting to evaluate their financial situations.  For some folks who have been out of work for more than a year, accumulating tens of thousands of dollars of unsecured debt is not unusual, but for these same people the idea of filing for Bankruptcy is a mental bridge that is just too far.

I’m here to tell you that filing for Bankruptcy is really not that bad.  Let’s start with where this perception comes from.  Historically, there were two legal proceedings that were considered personal failings:  1) divorce, and 2) Bankruptcy.  If you grew up before the 1980’s, both legal proceedings were a big deal, and it would not be unusual for your neighbors who either filed for divorce or bankruptcy were the subject of gossip and pity.

The stigma behind divorce largely went away when courts and legislatures approved “no fault” divorce, and today, your neighbor getting divorced is more like a footnote than a major subject of conversation.

The stigma behind filing for Bankruptcy started to go away in the 1990’s as the process became more popular amidst rising medical care costs, and mounting credit card debt.  It is also not a coincidence that this same period saw an explosive growth in student loan debt causing people to have to choose between paying their student loans and their credit card debt.

Bankruptcy filing was starting to become less stigmatized and more like divorce in the minds of most people when about twenty years ago, a strange thing happened.  For decades, the three major credit reporting bureaus (Equifax, Experian, and TransUnion) were obscure specialized services that were used by auto dealers and mortgage brokers.  The first Fair Credit Reporting Act was passed by Congress in 1970, but most people did not know what a credit report was.  About 20 years ago, the three major credit reporting bureaus figured out that they could market your credit score to you as a separate revenue stream.  Instead of just lenders and banks paying the three major credit reporting bureaus, now regular people were persuaded to pull their own credit reports and the three major credit reporting bureaus used the FICO score to encourage people to use this service.

People began to see their credit score like a “report card” on their life.  The closer to 800 your FICO score was the better you were doing.  You probably noticed that about twenty years ago people starting talking (or more like bragging) about their credit score.  Suddenly this was the metric by which people judged themselves, and it was a brilliant marketing move.  Of course, this was not reflective of reality.  Your FICO score is meant to be a measure of risk for lending money to you based upon past behavior.  A wealthy person who pays cash for everything has a 0 credit score because they have no history of credit, but a person who has $60,000 of credit card debt and is living pay check to pay check, and has never been late on a monthly minimum payment might be in the high 700’s for a FICO score.  That certainly does not mean that the 2nd person is more financially stable than the first person.

Because people began to hold their credit score as sacrosanct, suddenly the idea of filing for Bankruptcy (which would have a temporary negative affect on a FICO score) seemed like it was a taboo option, and Bankruptcy went back to having a very negative stigma associated with it.  People began to invest heavily in “credit consolidation” services that cost them thousands of dollars but did little to directly improve their solvency.

The truth is that Bankruptcy is simply not the terrible thing that people make it out to be.  In point of fact, most people saddled with debt will have their credit score dramatically improve within one year after a Bankruptcy filing.  People who could not qualify for an apartment will suddenly qualify.  The same goes for car loans, and yes (even though I don’t recommend it), even credit card offers will start to come in.

While it is true that initially many people’s FICO score will take a hit, this effect is temporary and begins to rebound after the case is discharged.  In fact, if your debt is overwhelming, your credit score will largely remain stagnant, even if you try to make payments on the debt.  In those cases, the only way to improve your credit score is to improve your “debt to income ratio”, by getting rid of the “debt” part of that ratio.

Nothing in life is free, and of course there are always consequences to every action, but the consequences associated with filing a Bankruptcy are best evaluated between you and an experienced attorney rather than by listening to anecdotal stories about Bankruptcy.  It is a very viable solution, and just like a divorce, you should NOT stay in a broken relationship with your debt if there is no hope of salvaging that relationship into something positive.

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