Bankruptcy vs Debt Consolidation: Credit score recovery – a detailed examination

Ah, Bankruptcy.  How terrible of you!  Society, friends and neighbors boo you. Debt consolidators tell you this as they promote their program.

But, what are the real issues with “both” bankruptcy vs debt consolidation?


    1. Your credit score


    1. Getting rid of your debts


    Keeping key assets

Let’s closely examine what happens to your credit score in bankruptcy vs debt consolidation.  In both cases, your credit score will have suffered tremendously.

IMPORTANT: Because this is a detailed examination, please read my previous blog: Credit Score Perils of Debt Consolidation

Here are three important rules to understand with bankruptcy:

Rule #1: Bankruptcy stays on your credit report for ten years. True, however, see rule #2.
Rule #2: Credit scoring considers a bankruptcy mainly for two years.
Rule #3: Many creditors deem bankruptcy as a fresh start with debt cleared away for their lending.

This will be our sample starting point:  Your credit score is 700. You have a stable job and you are paying your bills on time.  Suddenly you lose your job, use up your savings and start to fall further behind on your bills.  Creditors are pounding you and you have to do something.  Your credit score is now at 590.

At this point, you are considering bankruptcy chapter 7: liquidation of debts, bankruptcy chapter 13: restructuring your debts, or using a debt consolidator.

Lets chart the differences:

BK Chapter 7 liquidation BK Chapter 13 reorganization Debt Consolidation
Duration of program 5 months avg 4 years avg 3 years avg
Immediate effect on creditors Stops all collections, liens or garnishments Stops all collections, liens or garnishments Nothing, negotiations with your creditors begin after your fee period, usually 6 to 8 months. Your creditors are put on notice but there is no legal effect, collections continue.
Cost Low Medium High
Getting rid of unsecured debts Yes 40% reduction with payment plan 60% reduction with payment plan
Secured assets Liquidated Restructured payments Not addressed
Future creditors viewpoint Seen as a fresh start to many creditors. Seen as a cautious fresh start. Your payment plan will be scrutinized Disadvantage. Remember your creditors have to wait until your fee period has been paid.
When can your credit score start to recover? 6 months avg 6 months avg 18 months or ½ the duration, on avg
credit score before problems 700 700 700
credit score after problems 590 590 590
credit score 30 days after filing 545 545 570
credit score 3 months after filing 545 545 545
credit score 9 months after filing, with moderate new debt assumed and on time payments 610 575 credit score growth is held down because your debt to income ratio includes your bk13 payments 545 can’t get new loans or debt yet
credit score 12 months after filing, same criteria 635 605 545 can’t get new loans or debt yet
credit score 18 months after filing, same criteria 660 640 545 can’t get new loans or debt yet
credit score 24 months after filing, same criteria 670 660 575
credit score 36 months after filing, same criteria 670 685 a bit higher because your nearing the end of your bk13 payment program 630

This chart is an example only, each individual will vary. No specific recommendations are given.

As you can see, there are significant differences to your credit score based on which program you choose.

If you need any of these programs, consider the immediate effect on your creditors, the duration of the program, the reduction of your debts and very importantly, your credit score.

My recommendation is to first use the Action button to negotiate your debt directly.  This can offer you a way out of your debt with minimum credit score and financial impact. Then, if you must, do either bankruptcy or debt consolidation and give serious thought to the credit score effect.

David B. Coulter – founder and CEO of Smart Credit