CHICAGO — Consumers who enroll in third-party debt settlement programs may suffer larger credit score declines than those who file for bankruptcy, with many entering settlement programs while still current on their debts, according to a new analysis from TransUnion.
The analysis found that three months before entering debt settlement, consumers had a median VantageScore 4.0 credit score of 587, compared with 570 among consumers who later filed for bankruptcy.
TransUnion also found that near-prime consumers represented a larger share of debt settlement enrollees, potentially making it more difficult for lenders to identify borrowers who may be heading toward financial distress.
The difference became more pronounced after consumers entered debt settlement programs.
Among consumers who were current on their obligations when they enrolled, the median credit score fell from 645 six months before enrollment to 549 six months afterward — a 96-point decline. Bankruptcy filers experienced a 20-point decline over the same period, according to TransUnion.
‘Outcomes Can Vary Significantly’
“Consumers often view debt settlement as a less disruptive alternative to bankruptcy, but our research found outcomes can vary significantly based on a consumer’s circumstances,” Jason Laky, executive vice president and head of financial services at TransUnion, said in a statement.
Laky said consumers who entered debt settlement while current on their debts frequently experienced more severe score declines than bankruptcy filers.
“This underscores the importance of understanding settlement-related exposure when making credit and account management decisions,” he said.
Many Consumers Current When Entering Settlement
TransUnion said nearly half of debt settlement enrollees were current on their obligations when they entered a program. The company also said more than half were current at the time of enrollment when discussing its predictive-risk findings.
That suggests lenders relying primarily on delinquencies to identify borrowers experiencing financial difficulties could miss consumers preparing to enter debt settlement programs, according to the analysis.
TransUnion said lenders could potentially identify those consumers earlier by combining bankruptcy-related risk signals with trends in consumers’ credit behavior.
The Highest Risk
The company found that adding its TruVision credit attributes to a predictive model identified an additional 25% of debt settlement enrollees within the highest-risk 10% of consumers.
“Many consumers entering debt settlement programs are not yet showing traditional distress indicators such as delinquency,” Michele Raneri, vice president and head of U.S. research and consulting at TransUnion, said in a statement.
Raneri said indicators such as rising credit utilization, increasing balances and additional unsecured borrowing can help lenders detect potential debt settlement enrollment before borrowers become delinquent.
TransUnion Points to Early Warning Signs
Among the credit trends TransUnion identified as potential warning signs were rising balances, higher utilization, growth in unsecured personal loans and changes in consumers’ credit account activity.
TransUnion said financial institutions could incorporate those indicators into portfolio reviews, account management, prescreening and decisions involving credit line increases.
Earlier identification could also give lenders an opportunity to discuss alternative repayment options with borrowers before they enroll in third-party debt settlement programs, according to the company.
The findings indicate that debt settlement enrollment itself can be an important risk factor even when consumers have not yet missed payments, TransUnion said.
