FICO Data Reveals That Settling Your Debts Damages

Your Credit Scores Less Than Filing for Bankruptcy

FICO, the company that calculates consumers’ FICO scores — the scores that are the most widely used by American creditors to determine whether or not they will extend credit to a particular consumer and the terms of that credit — recently released data showing how different negative actions consumers might take in regard to their credit will affect their scores. Among other things, the data shows that settling your debts is far less damaging to your FICO scores than filing for bankruptcy. In other words, the data helps make the case for why settlement rather than bankruptcy is an excellent alternative for many cash-strapped consumers, assuming that they either settle their own debts or work with a reputable settlement firm that charges fairly for its services.

The data released by FICO and available on its web site at: http://www.myfico.com/crediteducation/questions/Credit_Problem_Comparison.aspx, shows that as a consequence of filing for bankruptcy, consumers may see as much as a 240 point drop in their FICO scores. In contrast, if they settle their debts, their FICO scores may drop by 125 points at most. Interestingly because of the way that FICO scores are calculated, when consumers have higher scores prior to either filing for bankruptcy or settling their debts, their credit scores are harmed more by settlement or bankruptcy than are the scores of consumers who had lower FICO scores to begin with. According to FICO, the reason for this difference is that the scores of lower scoring consumers already reflect their credit missteps.

Despite the FICO data, I must caution you not to base your decision about which debt relief option to pursue based on that information. All debt relief options — credit counseling, settlement and bankruptcy — will have a negative effect on your credit histories and/or FICO scores for some time. (See my recent blog, Debt Relief Options vs. Your Credit Score).

When you are deciding how to deal with your debt, your primary concerns should be gaining a clear understanding of how each option works and its pros and cons, and determining whether the numbers associated with a particular option make sense for you. For example, your first test if you are considering settlement should be whether or not you can accumulate the money you need to fund your creditors’ settlement offers before your risk of being sued by them for what you owe begins to escalate. If you cannot come up with the money you need to settle your debts relatively quickly, then bankruptcy is probably your better option.

For free help determining which debt relief option would work best for you, fill out CRN’s consultation request form.

In a recent blog post written by Diane Stafford with the Kansas City Star entitled: Bankruptcy filing thwarts re-employment, Stafford highlights a key reason why consumers who can qualify for a Chapter 7 liquidation of debt bankruptcy should research ways to avoid it, if at all possible.

One of the primary benefits of filing for Chapter 7 bankruptcy is that your unsecured debt, like credit card debt, gets discharged or wiped out, which gives you the financial fresh start you need if you are strapped with too much debt. However, as Stafford points out, not only will your bankruptcy be part of the public record and noted in your credit report for 10 years, but in today’s job market having that information in your credit file can make it much more difficult to find a well-paying job. That’s because there is a lot more competition for good jobs and so many employers are using other criteria besides an applicant’s resume and references to help them decide who is the “best” person for the position they want to fill. In many instances, one of those criteria is whether an applicant has filed for bankruptcy. The theory is that if an applicant can’t manage her own money, then she probably has bad judgment and would not make a good employee. Of course, as Stafford points out, this attitude does not take into account why an applicant filed for bankruptcy. For example, the applicant may have an ex-spouse who is not paying her the child support she is legally entitled to or the applicant’s health insurer is refusing to pay many of the medical bills associated with his wife’s serious illness.

Therefore, professionals who have been downsized or are concerned that they may lose their jobs should recognize how easy it is to hit the debt wall when they are out of work and should take aggressive steps to address their debt. Although filing for bankruptcy is an option to consider, they should also consider other alternatives, like debt negotiation. Debt negotiation has proven to be an effective option for credit relief and can prevent a bankruptcy from appearing on your credit report.

Debt negotiation involves contacting your creditors, such as the banks that issued you credit cards, to try to reach a compromise with them regarding how much money you’ll have to pay to pay off your accounts. Your goal during your negotiations is to get each of your creditors to agree to take less than the outstanding balance that you owe and for the amounts that that they agree to accept to be amounts you can afford. These negotiations are typically predicated on your having missed several consecutive payments on your accounts and on your ability to establish that a hardship — like a job loss — has made it impossible for you to pay your outstanding balances.

Until recently, large creditors, especially banks that issue credit cards, have had long-standing policies regarding when they will offer a settlement to a consumer and when they will consider a settlement that a consumer offers to them. Now however, given the current state of our economy, the troubles within the banking sector, the financial industry’s new focus on risk aversion, and increases in account charge off percentages, many banks have not only become more willing to settle credit card debts, but they are also willing to settle for less money than they would have agreed to in the past. This is good news for debt stressed consumers.

In her blog, Stafford mentions the plight of one professional who might have been able to avoid bankruptcy if he had pursued debt settlement after he lost his job. She writes: “I heard from a professional who lost his job in a March 2008 downsizing at Sprint and began a so-far fruitless job search. His severance ran out, he and his wife depleted three 401(k) savings accounts and used up other savings. They pinched all the pennies they could and are trying to keep their home through a Fannie Mae Loan Modification program.”

The plight of that individual sounds very similar to stories I hear all too often. After losing a job, or experiencing a cut in pay, consumers are optimistic that things will work out for them and so while they are looking for work, they use up their savings and draw down the money in their 401(k)s so they can pay their living expenses and their debts. However, once their money runs out and they are still jobless, many of these consumers end up in bankruptcy. Although I am not criticizing the optimism of these consumers — they need it to help them get through the tough times ahead — I am suggesting that many of them might have made better use of the money in their savings and retirement accounts by using it to settle with their creditors. That way they could have avoided bankruptcy and possibly made it easier to find new well-paying jobs.

Although there always has been and always will be consumers who will benefit more from a Chapter 7 than from negotiating their debts, the fact is that many debt-stressed consumers who do file were actually excellent candidates for debt settlement.

If you have hit the debt wall and want to learn about all of your debt management options, including debt settlement, visit Consumer Recovery Network. While you’re there, become a member of Consumer Recovery Network (CRN), with no risk to you, and find out if you should pursue debt negotiation.