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Can bankruptcy actually help a credit score over the long run?

There are a myriad of reasons as to why those in dire financial straits should consider the fresh start offered by filing for either Chapter 7 or Chapter 13 bankruptcy. For starters, it not only helps eliminate otherwise insurmountable debt, but also puts an automatic stay into effect, such that all collection efforts (wage garnishment, collection calls, etc.) must come to an immediate halt.

The unfortunate reality, however, is that despite these benefits, many people steadfastly refuse to consider filing for bankruptcy. For some the refusal boils down to a matter of pride or feeling as if they have an obligation to pay what they owe, while for still others, it boils down to the fear that it will permanently destroy their credit score.

While this fear concerning a credit score is understandable, it's also a bit unfounded. In fact, many experts argue that a person's credit score could actually benefit from a bankruptcy filing in the long run.

How is this possible?

Experts argue that most people who are in a position to consider filing for bankruptcy have likely been struggling with debt for quite some time, such that their credit score has already taken a substantial hit.

While they could elect to continue on this same path, which only result in more damage to their credit score over the long run, experts argue they could also file for bankruptcy, which would not only see many of their financial problems resolved, but their credit score actually start to trend upward once more.

If this seems hard to believe, consider the findings of a study conducted by the Federal Reserve Bank of Philadelphia of individuals whose credit score plummeted in the 18 months prior to filing for personal bankruptcy in 2010:

  • Among the individuals under study who filed for Chapter 7, their initial average credit score (using Experian's scale of 280 to 850) was 538.2. However, when their cases were discharged within an average of six months, their scores rose to 620.3.   
  • Among the individuals under study who filed for Chapter 13, their initial average credit score was 535.2. However, when their cases were discharged within an average of six months, their scores rose to 610.8.   

What all of this serves to underscore is that some of the fears concerning bankruptcy are misplaced. Indeed, rather that dismissing it as an option outright, financially distressed individuals may at least want to consider the possibility of sitting down with an experienced legal professional to learn more about the process. 

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