If you are close to bankruptcy, your lenders probably already know about it. Credit reporting agencies have their own formulas that predict the likelihood of bankruptcy. The general public never sees these bankruptcy scores, but they are sold to lenders, and these lenders use the scores when considering loan applications.
Bankruptcy scores are similar to credit scores. The scoring models pull information from consumer credit reports.
Experian's BankruptcyPredict uses Visa transaction spending characteristics, Experian consumer credit information and balance trending data as well as the most current credit card transaction and credit profile behaviors for consumers. It uses this data to predict the consumers most likely to create bankruptcy losses for lenders over the next 24 months.
FICO Bankruptcy Scores rank consumers according to a likely bankruptcy loss ratio--bankruptcy losses divided by revenue. FICO describes its score as "an effective tool for retail cards, bankcards and other revolving accounts, as well as for installment loans, telecommunications/utilities accounts and other credit portfolios."
This is another example of how credit agencies gather, package and distribute personal data that is then used to make judgments about the consumer. This bankruptcy score is used to decide whether to give you a loan and what your interest rate will be on that loan. Consumers should examine their credit reports to see what accounts need to be paid down.
Factors that translate into a high bankruptcy score for consumers are delinquent accounts, credit card balances that are close to the credit limit, and other large debts. The number of new credit accounts also draws attention as distressed borrowers typically try to find new lines of credit as they run out of money and options.
Lenders Act Sooner to Avoid Bankruptcy Losses Later
When a borrower declares bankruptcy, the lender may not be able to collect any of the outstanding debt. This is much costlier than a "charge-off," where the lender can still attempt to collect the loan or sell the outstanding debt to a collection agency. The lenders use the bankruptcy scores to possibly take early action against high-risk accounts. Lenders want to define and draw a line between the accounts that are too risky and those that look risky but could be very profitable. Risky lenders pay the highest interest rates and fees and lenders don't want to sacrifice this revenue.
Bankruptcy scores provide an early warning with pre-bankruptcy signs and lenders can step in and make changes to prevent losses before it is too late.
Bankruptcy's Impact on Consumers
A bankruptcy is a very negative event on your credit report. It will pull down your credit score as long as the bankruptcy is listed on your credit report, usually seven to ten years.
The negative impact on your credit score varies, depending on what your score was before bankruptcy took place. If your score was already low, it may not have a substantial effect. On the other hand, a significant drop would likely occur if you had a good credit score. According to the New York Times, a bankruptcy can cut your FICO score by 130 to 240 points.
The number of bankruptcies is actually falling in the United States. In the 12-month period ending June 30, 2012, there were 1,661,831 pending bankruptcies, down 2.5 percent from 1,704,548 the year before.
There are some things consumers can do to soften the effects of bankruptcy.
- Start building a good payment history by paying all bills on time.
- Check your credit report to make sure that only the accounts in the bankruptcy filing are reported with bankruptcy status.
- Re-establish credit as soon as possible. Start with a secured card and make your payments on time.