Is Bankruptcy More Damaging Than an Account in Collections?
One of the most severe drawbacks to filing for personal bankruptcy is the damage done to your credit report. Personal bankruptcy---either Chapter 7 or Chapter 13 bankruptcy -- results in a severe downgrading of a person's credit score, as the majority of his debts are usually written off or subject to a settlement. While a payment late more than a month will cost a person between 60 and 110 points, a bankruptcy can cost as much as 240 points.
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Bankruptcy
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When a person files for bankruptcy, most of his debts are written off. A trustee in the bankruptcy will collect the person's assets and sell them off, so as to provide partial payment to creditors. Generally, creditors will receive only a fraction of the amount they lent out. Because these debts are not repaired, the filer's credit rating suffers enormous damage. A personal bankruptcy will remain on the person's credit report for up to 10 years.
Account in Collections
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When a debt is outstanding for a long period of time, the company that lent out the money may send the overdue account to its collections department or to an outside collection agency. When this happens, credit reporting agencies list the account as being in collections. This will invariably have a negative effect on the person's credit score. However, the person can still pay off the debt as opposed to bankruptcy.
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Considerations
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In the short term, bankruptcy is more damaging to a person's credit history than an account in collections. According to the Fair Isaac Corporation, the company that invented the modern credit score, a bankruptcy will drop your score up to 240 points. If your score is 680, bankruptcy will cost you 130-150 points; if your score is 780, it will cost you 220-240 points. By contrast, a payment late more than a month will cost a person with a 680 score 60-80 points and a person with a 780 score 90-110.
Other Effects
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The effects bankruptcy and accounts in collections have on a person's life are not limited to their credit report. While bankruptcy can result in a person being stripped of many of their assets or facing a total reorganization of their finances, the process does provide them protection from creditors. By contract, a person who has an account in collections may face harassment from one or more collection agencies, which can also have a disruptive effect.
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