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Bankruptcy scars: the long term impact of clearing the deck

Published: Friday, Jan. 4 2013 6:30 a.m. MST

What is the long term impact of declaring bankruptcy? New studies show negative impacts on labor market participation, family life and health and well being.

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When debt becomes overwhelming, personal bankruptcy is an option some people use to clear the decks. While this option addresses immediate cash flow difficulty, it doesn't come without consequences.

One of the most well know, well documented long term impacts of personal bankruptcy is that is reduces a person's ability to secure low cost loans for education or housing.

But are there other areas of people's lives that are negatively impacted when they declare bankruptcy?

A 2012 study by Michelle Maroto at the University of Alberta found the effects of bankruptcy spill into the labor market. Using data from the National Longitudinal Survey of Youth, Maroto found that people who declare bankruptcy work fewer hours for lower wages than their peers who have not declared bankruptcy. Explaining a potential reason for this finding Maroto wrote:

"The transmission of bankruptcy's stigma across markets occurs in a specific legal setting where, even though the current U.S. Bankruptcy Code grants bankrupters a fresh start through debt forgiveness, the Fair Credit Reporting Act limits bankrupters' ability to begin anew because it permits employers to access credit reports."

Employers' ability to check the credit scores of potential employees allows them to discriminate against those who have declared bankruptcy in the past.

Bankruptcy and financial hardship also have social and psychological impacts. Researchers at Carleton University in Ottawa, Canada, found that individuals who declare bankruptcy and the associated financial stress, experience lowered self-esteem, an increasingly pessimistic outlook on life, and an increase in depression. They noted financial stress to be associated with physical ailments such as headaches, stomachaches and insomnia.

Family relationships are also impacted by bankruptcy. Marital discord increases as do incidents of relationship dissolution, according to Carleton researchers. They found that fathers under financial pressure are less likely to be responsive to the needs of their children and less consistent in disciplining their kids when they misbehave.

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