Available at:  TransUnion — Debt Settlement Enrollment Linked to Greater Credit Score Declines Than Bankruptcy

Debt Settlement May Hurt Credit Scores Far More Than Bankruptcy — TransUnion Has the Numbers

One of the most persistent myths about bankruptcy is that filing will “destroy your credit” and that debt settlement is therefore a safer, gentler alternative.

New research from TransUnion suggests almost exactly the opposite—particularly for consumers who enter debt settlement while they are still current on their debts.

And this is not research commissioned by bankruptcy lawyers. It comes from one of the three major credit reporting agencies.

TransUnion compared consumers enrolled in third-party debt settlement programs with bankruptcy filers and control groups, examining credit behavior for 24 months before and after enrollment or filing. The study controlled for risk tier, age, and lender distribution, although TransUnion appropriately cautions that its data came from participating lenders and therefore should not necessarily be treated as representative of the entire industry.

The headline result is striking.

Debt Settlement: A 96-Point Drop Versus 20 Points for Bankruptcy

For consumers who were current on their debts when they enrolled in debt settlement, the median VantageScore 4.0 fell from 645 six months before enrollment to 549 six months afterward—a 96-point decline.

Bankruptcy filers went from 582 to 562—a decline of only 20 points. (TransUnion Newsroom)

 

Debt Settlement Consumers Saw Greater Credit Score Declines Than Those Who Filed for Bankruptcy





	Consumers Enrolled in Debt Settlement Programs			Consumers Who Filed for Bankruptcy
	Current	30-90  Days Past Due	120+  Days Past Due
Six months pre-enrollment	645	623	573	582
At enrollment	582	519	525	556
Six months post-enrollment	549	551	551	562
Difference pre- vs. post- enrollment	-96	-72	-22	-20

 

Source: TransUnion analysis. (TransUnion Newsroom)

That chart deserves more attention than virtually any advertisement promising that debt settlement is a way to avoid the supposed credit catastrophe of bankruptcy.

The comparison becomes particularly interesting as consumers become more delinquent. Someone already 120+ days delinquent before debt settlement lost 22 points—almost exactly the 20-point decline for bankruptcy filers. The enormous difference occurred among consumers who were still current: 96 points versus 20.

As TransUnion's Jason Laky explained:

“For consumers who entered debt settlement while current on their obligations, score declines were often more severe than those observed among bankruptcy filers.” (TransUnion Newsroom)

Why Bankruptcy Doesn't Necessarily “Destroy” Credit

There is an important qualification.

This does not establish that filing bankruptcy somehow causes less credit damage in every case. The starting populations are different.

Michele Raneri of TransUnion explained to BadCredit.org that debt-settlement consumers who were current started at a substantially higher median score—645 compared with 582 for bankruptcy filers—so they had considerably farther to fall. She also explained that bankruptcy filers often had serious financial distress and delinquencies before bankruptcy appeared on their credit reports. Consequently, much of their credit-score deterioration had already happened before filing. (BadCredit.org)

That qualification is important, but it hardly rescues the conventional warning that consumers should avoid bankruptcy because of what it supposedly does to their credit.

The more useful question isn't:

“Does bankruptcy hurt my credit?”

Of course financial distress hurts credit.

The better question is:

“If I already cannot realistically pay my debts, which available solution stops the damage and allows me to start rebuilding sooner?”

On that question, the TransUnion research should cause consumers—and particularly attorneys reflexively steering clients away from bankruptcy because of credit-score concerns—to reconsider some assumptions.

Debt Settlement Can Manufacture Delinquency

Perhaps the most troubling finding is that 53% of the debt-settlement consumers studied were current when they enrolled.

That matters because many debt-settlement programs depend upon exactly what financially responsible consumers have spent years trying to avoid: stopping payments to creditors.

As Audrey Downs of GreenPath told BadCredit.org, debt-settlement programs commonly require consumers to pause payments while settlements are negotiated, potentially producing late fees and substantial credit damage. And creditors remain free to reject settlement proposals. (BadCredit.org)

The TransUnion data also show that these consumers often were using increasingly large amounts of credit before settlement. Among consumers who were current when they enrolled, average credit-card balances increased from about $7,112 two years before enrollment to $14,547 at enrollment, while utilization increased from approximately 51% to nearly 78%. Personal-loan balances likewise increased from approximately $12,404 to $19,969.

And within six months after enrollment, roughly half of the credit cards belonging to both current and delinquent debt-settlement consumers had been closed.

That creates a rather perverse result: a consumer who has managed to remain current can enter debt settlement precisely because she wants to protect herself from bankruptcy, only to be instructed to become delinquent and then suffer substantially greater credit-score deterioration.

 

Bankruptcy Has Something Debt Settlement Doesn't: A Finish Line

There is also a fundamental difference that a credit-score comparison cannot capture.

Bankruptcy is a legal process.

A Chapter 7 debtor generally receives a discharge within a matter of months. The automatic stay generally stops collection activity immediately. A creditor does not get to decide whether it feels like participating in the debtor's discharge.

Debt settlement is negotiation. A creditor can refuse to settle, continue collection activity, or sue.

And there is another rather enormous difference:

The Chapter 7 debtor generally keeps the money that otherwise would have gone toward paying unsecured creditors.

That sounds obvious, but it is frequently lost in comparisons between bankruptcy and debt settlement.

A debt-settlement consumer may spend years paying and paying and paying into a program—funding settlements and often substantial fees—before finally resolving the debts. During that same period, the consumer may suffer delinquencies, collection calls, lawsuits, closed accounts, and damaged credit.

A qualifying Chapter 7 debtor may instead discharge those same credit-card and personal-loan debts without paying them at all. The money that would have been devoted to debt settlement can instead go toward rent or a mortgage, groceries, transportation, retirement savings, an emergency fund, or simply rebuilding the household's financial stability.

That difference is particularly important because TransUnion found that 53% of debt-settlement enrollees were still current when they entered the program. These were not necessarily consumers whose credit had already collapsed. Some were still sending substantial amounts of money to creditors before entering a process that could then require them to stop paying, become delinquent, and accumulate money for settlements.

As Andrew Pizor, Senior Attorney at the National Consumer Law Center, put it:

“Most people considering debt settlement would be much better off in a chapter 7 bankruptcy. It’s faster, more reliable, and cheaper.”

And the word “cheaper” deserves at least as much emphasis as “faster” and “more reliable.”

The comparison should not merely be:

Debt settlement versus bankruptcy: Which hurts my credit score less?

It should be:

At the end of two or three years, what will my credit look like—and how much of my money will I still have?

Commentary

Bankruptcy attorneys have heard the same sentence thousands of times:

“I don't want to file bankruptcy because it will ruin my credit.”

That fear is understandable. It has also been enormously profitable for companies selling alternatives to bankruptcy.

The TransUnion research supplies an important corrective.

It does not prove that bankruptcy improves credit scores or that every consumer should file bankruptcy. Consumers who can afford to repay their debts through ordinary repayment, legitimate hardship arrangements, consolidation, or a nonprofit debt-management plan may have excellent reasons to do so.

Nor is every debt settlement necessarily inappropriate.

But consumers should be extremely skeptical of the proposition that debt settlement inherently protects either their credit or their money better than bankruptcy.

For consumers in TransUnion's study who entered debt settlement while still current, the median credit-score decline was not slightly worse than bankruptcy.

It was nearly five times larger: 96 points compared with 20 points. TransUnion's underlying study further concluded that it did not observe “a consistently stronger credit recovery outcome” for debt-settlement participants.

But even that comparison understates the potential difference.

Imagine two otherwise similar consumers with $50,000 of dischargeable credit-card debt.

One enters a debt-settlement program and spends the next several years accumulating money to settle those accounts, paying settlements and fees along the way.

The other qualifies for Chapter 7, obtains a discharge within months, and keeps the thousands of dollars that otherwise would have been handed over to settle old unsecured debts.

Even if their credit scores ultimately followed precisely the same path—which TransUnion's research certainly does not establish—the Chapter 7 debtor could emerge from that period with substantially more money available to build an emergency fund, save for retirement, replace a car, make a down payment, or otherwise rebuild.

That is the part of the supposed “credit preservation” argument for debt settlement that is too often ignored.

Credit is a means, not an end.

Having a somewhat better credit score is of questionable value if achieving it requires spending $20,000, $30,000, or $40,000 paying old debts that could legally have been discharged. And TransUnion's research now raises an even more uncomfortable possibility: the consumer might spend all that money and suffer a greater credit-score decline anyway.

Bankruptcy offers something fundamentally different: a legally enforceable discharge, preservation of income that otherwise would service dischargeable debt, and a definite point from which financial recovery can begin.

The real fresh start therefore isn't just about a credit score.

It is about stopping the endless cycle of paying yesterday's debts so that the consumer can finally start using today's income to build tomorrow's financial security.