Personal Bankruptcy Consequences & Alternatives
- Credit scores are adversely affected whether negotiating debt settlement or declaring bankruptcyragged purse image by Oleg Kulakov from Fotolia.com
Bankruptcy is a process by and through which the federal government affords legal protection to a consumer from creditors to discharge debts that cannot be repaid. During the personal bankruptcy process, a trustee is named to catalog all outstanding debts and sell assets that are not protected under the bankruptcy code.
For individuals, there are two primary types of bankruptcy protection: Chapter 7 (liquidation) and Chapter 13 (reorganization). The main consequences of bankruptcy are negative effect on credit rating and reapportioning of debt-to-income ratio. Alternatives are self-negotiation and debt consolidation/settlement. - A common misconception about filing bankruptcy is that it will damage an individual's credit rating far more than if the consumer just negotiated the debt individually or through an intermediary (such as a debt consolidation company). While it is true that a bankruptcy remains on a consumer's credit report for up to 10 years, negative credit entries remain up to three years every time there is action on the account. In other words an individual's credit score is adversely affected each time they make a payment or even make an agreement---this can mean the debt is restarted over and over.
An individual's credit rating will suffer immensely whether they file for bankruptcy or allow the debts to compile and attempt to take any action. Moreover, an individual considering bankruptcy is extraordinarily likely to have already suffered a substantial credit score reduction.
In any event, the damage to the creditworthiness of the consumer will be severe enough that he will likely be ineligible for revolving loans for at least 1-2 years and home and car loans for at least 4-8 years. - A positive consequence of filing for personal bankruptcy protection, an individual's debt-to-income reduction will be reduced (DTI ratio is the percentage of recurring monthly debt consisting of mortgage or rent, credit cards, student loans, and car loans divided by gross monthly income---a healthy DTI should be no more than 35 percent).
Because all unsecured debts (credit cards, medical bills, some judgments) are discharged, the individuals under personal bankruptcy protection will see a positive effect on their DTI. - Consumers can negotiate with creditors on a one-on-one basis. Individuals seeking to do so must be able to offer at least 10 to 25 cents on the dollar and be prepared to go up to as much as 40 to 50 cents on the dollar (payable in a one-time, lump sum payment) and get each agreement in writing. Only after the agreement has been tendered and placed in writing that the creditor is accepting a partial payment for the entire debt and will not pursue future collection actions or legal actions, the individual should settle the debt with a cashier's check, certified check, or money order, mailed by USPS Certified Mail.
- Debt consolidation companies are another alternative to bankruptcy. These companies specialize in negotiating a consumer's debt with creditors on the debtor's behalf. Although an alternative to bankruptcy, debt consolidation and/or settlement will not save a consumer's credit rating from being damaged. Individuals seeking this alternative should be aware there are strict provisions for which these consolidations or settlements are to be repaid (such as direct debit payments).
