How Debt Relief Affects Your FICO Credit Score: Comparing Bankruptcy vs. Debt Settlement
Your credit score is an up-to-date snapshot of your financial life. In the United States, there are three major credit bureaus that compile and issue credit reports for consumers. Virtually every American adult has a so-called FICO credit score.
Consumer credit scores range from a rock-bottom reading of 300 to a pitch-perfect score of 850. Of course, the vast majority of Americans fall somewhere in between these two readings. Scores below 620 are generally considered to be fair or poor. Although 620 is not a hard-and-fast benchmark, scores in the mid-600s or higher are generally regarded as acceptable or good. Scores greater than 750 are considered to be excellent.
When you apply for a mortgage, car loan or credit card, your lender will run your credit score with one of the three major credit bureaus. It’s important to remember that each bureau maintains a slightly different record of your credit history. As such, your exact credit reading will vary depending upon the bureau that your lender selects. Unless there’s a major piece of information missing from one or more of these bureaus’ records, your score is unlikely to fluctuate significantly between them.
However, your credit score will fluctuate based on the credit-related decisions that you make over long periods of time. There are many different actions and non-actions that can positively or negatively affect your credit. If you wish to improve your credit score, it’s crucial that you understand how each of these decisions can affect your financial reputation.
If you’re reading this, there’s a good chance that you’re grappling with a significant amount of unsecured debt. Since they often come with high interest rates and relatively low spending limits, unsecured debts like credit cards and personal lines of credit can be especially devastating when used improperly. As your debts mount and you consider taking drastic action to keep your financial house from collapsing, you’ll want to consider how each of your debt-relief options could affect your credit score over the long term.
If you’re unable to dispose of your debts by adhering to an aggressive payment schedule or using a credit counseling service, you’ll have two principal debt-relief options: debt settlement and bankruptcy. Both of these methods of debt relief can have serious implications for your credit score. Unfortunately, a temporarily-diminished credit score is the necessary price of a fresh financial start.
Bankruptcy is a powerful debt-relief tool. When you declare Chapter 7 bankruptcy, the bulk of your assets may pass into the control of a court-appointed trustee for division among your creditors. Since your secured creditors may be entitled to seize or sell the assets that underlie their loans, you may not escape from the Chapter 7 bankruptcy process with your car or house.
Since bankruptcy can linger on your financial record for seven to 10 years, it’s not advised except in the most dire of financial circumstances.
In addition, your credit score will take a serious hit after your bankruptcy declaration. The amount by which your credit score drops once you’ve declared bankruptcy will depend upon its pre-filing value.
Your credit score is essentially a “risk profile” that exists to predict the likelihood that you’ll make poor financial decisions. As such, a “surprise” bankruptcy declaration that blindsides your creditors will affect your score far more than an “expected” declaration that comes after you’ve accumulated multiple delinquent loans and maxed-out credit cards.
If your credit score is 800 immediately before your bankruptcy declaration, it could drop by up to 250 points. If your credit score is a more modest 600, it might drop by only 150 points. Of course, the end result of either scenario will be the same. In either case, you’ll find it far more difficult to procure reasonably-priced loans and lines of credit following your bankruptcy.
For several reasons, many financial professionals consider debt settlement to be a superior alternative to bankruptcy. One of the principal reasons is its relatively mild effect on the typical borrower’s credit score.
When you enroll in a program of debt settlement, your credit score is all but guaranteed to drop. The same basic rule that governs the post-bankruptcy credit score drop holds true for post-settlement drops: Higher credit scores tend to fall farther than lower credit scores.
However, the post-settlement drop is both less jarring and shorter-lived. In general, a program of debt settlement will cause your credit score to drop by about half as much as a declaration of bankruptcy. Since the post-settlement drop is typically smaller, it’s measurably easier to begin rebuilding your credit after debt settlement than after bankruptcy. Since your credit score won’t be depressed to such a tremendous degree, you’ll have more opportunities to procure the credit facilities that you need to begin rebuilding your financial life.
There are plenty of additional reasons to choose debt settlement over bankruptcy. Whereas bankruptcy immediately becomes a matter of public record and remains open to discovery by your future employers and lenders, debt settlement is a discreet process.
The debt settlement process also tends to wrap up within two to four years and may successfully wipe away thousands of dollars in outstanding unsecured debts. By contrast, the unintended consequences of bankruptcy may linger for years. During that time, you may be unable to obtain a car loan, credit card or bank account.
Unless you’re willing to live with depressed credit for the better part of a decade, you should strongly consider enrolling in a program of debt settlement to help reduce your debts. You’ll be glad that you did.