I hear advertisements for all kinds of alternatives to bankruptcy which imply that they will not hurt your credit. I have always been put off by these claims because either you are paying your bills on time and in full, or you are not. If you are not, your credit gets hurt. I note how subtle these ads are in their deception. They will say things like, “don’t ruin your credit by filing bankruptcy.” They do not say that you will not ruin your credit with them, as that would be a provable lie. Instead it is merely implied. I challenge whether bankruptcy is as destructive to credit as commonly believed. It is generally easier to recover your credit after bankruptcy then it is from these alternatives. However, I will acknowledge that bankruptcy looks bad on a credit report. However, it turns out that these alternatives look just as bad.
I recently saw this article at, BostonHerald.com. Apparently, there is a new Federal program which will enable some people who have made all of their mortgage payments on time, but whose houses are worth less than they owe, to have a short sale of the house. Before this program, the banks generally required that you be several months behind on your mortgage payments before they would allow a short sale. It turns out that such short sales will “cause FICO credit scores to plummet”. It turns out that the credit scorer (Fair Isaac) treats people who have short sales the same “as people who’ve been foreclosed upon, filed for bankruptcy, had a tax lien or collection account.” Anthony Sprauve, a spokesperson for Fair Isaac Corp., developer of the FICO score, says that “in general, when a ‘loan (is) paid off for less than the full balance, it is classified as a severe negative item” by the FICO scoring model, and “there are currently no plans to change,” Sprauve added. As such, all of these alternatives to bankruptcy end up having the same destructive consequences to your credit score as a bankruptcy would. However, they are less comprehensive, less effective, not guaranteed to work, and usually take longer or cost more. Put another way, you can usually recover from bankruptcy quicker than you can recover from any of the alternatives and, in most cases, bankruptcy simply works better and is a better value. There are certainly exceptions to that statement, and I had a few occasions in my career where I have suggested that the client follow a alternative path to the bankruptcy path. But for most people I have encountered, bankruptcy is better than the alternative, even from the point of view of impact on credit.