Bankruptcy can be better for your score than ignoring debt

This post originally appeared May 17, 2018 on as “Credit score impact of ignoring card debt while living on Social Security income

By Barry Paperno

Dear Speaking of Credit,
I’m 70 years old, on Social Security income, and have about six credit cards with about $20,000 charged (medical and living expenses). I don’t care about my credit rating, though I do have a mortgage and have never missed a payment. Someone told me just ignore the credit card debt, since they can’t get you for anything. What should I do? – Ron

Dear Ron,
Yours sounds like a classic case of expenses – medical and otherwise – far exceeding what Social Security alone can cover. It makes perfect sense then to be looking for a way out from under those $20,000 in credit card debt.

Your proposed idea of simply “ignoring” the debt is one of a couple of solutions – the other is filing for bankruptcy.

We’ll examine both alternatives in terms of cost, preserving your assets and impacts to your current and future credit scores.

Effects of ignoring card debt
Beginning with your first missed payments, and extending for approximately the first six months of nonpayment, you can expect:

  • Calls and letters demanding payment.
  • Closed accounts, late charges and a higher APR.
  • Derogatory reports to the credit bureaus.

Following those six months of nonpayment, the card companies will write the debts off as a loss, reporting them as charge-offs to the credit bureaus.

In most cases, the card issuers then will assign the defaulted balances to collection agencies that will aggressively contact you for payment, while threatening legal action and placing additional score-dropping collection items on your credit reports.

Lastly in this process, though you are likely to be considered “judgment proof” based on your reliance on Social Security income, you could be sued by one of your creditors or collection agencies. This also would add a court judgment to the assortment of derogatory information your credit report will have acquired by then.

Effects of filing for bankruptcy due to card debt
There are two types of bankruptcy for consumers looking to discharge debt, whether in good standing, delinquent or in default:

  • Chapter 7 cancels many, or all, of your debts.
  • Chapter 13 consists of a plan to repay all, or part, of your debts.

The “ignoring debt” option tends to add derogatory information to your credit report over a year or longer time period.

Under Chapter 7 or Chapter 13 bankruptcy, on the other hand, your creditors and the credit bureaus will be given your bankruptcy information within about 30 to 60 days of filing.

Your card issuers will then close your accounts, stop all collection communication and report your accounts to the credit bureaus with the derogatory notation, “Account included in bankruptcy.”

Cost of each option: Ignoring card debt versus bankruptcy
If you have a high tolerance for collection calls and letters, a good reason to simply ignore the debt is that doing so can come quite cheaply. Just don’t answer the phone when creditors or collectors call, and put their collection notices in the trash.

Bankruptcy, by comparison, comes at a hefty price, since you will want to hire an attorney to handle the paperwork and court filings.

Depending on the extent of the debt and whether a Chapter 7 or 13 is being filed, the attorney and filing costs can range from $1,500 to $4,000.

Protecting your assets when ignoring card debt or filing bankruptcy
Fortunately, both options should provide cover for your income and home, since:

  • Your Social Security benefits cannot be taken from you by a creditor.
  • As long as your mortgage remains in good standing, your home will not have to be sold to satisfy the debt. Also, a creditor will not be able to tap into your home equity via a lien when protected by the homestead exemption for your state.

Credit scoring impacts of ignoring debt versus bankruptcy
Then there is the matter of your credit rating.

While it may be true that you will have no further need for good credit, you might like to what happens to your credit when you ignore your debt or file for bankruptcy.

First, a few important facts concerning the effects of credit information arising from unpaid debt:

  • Most derogatory credit reporting stays on your credit reports for seven years. The only exception is Chapter 7 bankruptcy public record items, which remain on your report for 10 years.
  • When all else is equal, there is little difference in scoring impact among a charge-off, collection, judgment or account included in bankruptcy.
  • However, each one of these is capable of lowering your credit score by more than 100 points.
  • The more recently the latest negative item was added to the credit report, the lower the score is likely to be.

Considering how strongly the score is affected by recently reported derogatory information versus older derogatory information, it may seem odd to want the last of the negative items to hit your credit report as soon as possible.

Yet, for future score rebuilding purposes, the sooner your score essentially “bottoms out” – typically within the 500 to 600 score range – the sooner it can begin the road to recovery.

With good behavior that path can take you to a credit score of 700 points or higher in as little as three to five years.

Which option is best from the credit scoring perspective?
Summarizing what these two avenues of debt resolution might mean for you:

  • While you’ll be defending your home and income in either situation, ignoring the debt entirely should cost you nothing to implement when compared with the attorney and filing fees required for bankruptcy.
  • Once filed and your creditors notified, bankruptcy can offer peace of mind by shielding you from creditors and collectors who will relentlessly threaten you with legal action.
  • The quick, orderly and systematic means for discharging debt through bankruptcy can offer the added benefit of enabling your credit score to recover more quickly, should circumstances change and you wish to re-establish credit sooner than later.

Best of luck to you!

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