Lenders look for ways to loan money but they also look for ways to reduce their risk to losses. Credit scores are just one measure of risk lenders look at. You may not be aware of one more tool lenders use to deny access to credit, which is called a bankruptcy score.
Credit score vs. bankruptcy score
The traditional credit score tells your lender about your overall creditworthiness. It measures the likelihood that you’ll default on a payment. A low credit score can mean a higher interest rate will be applied to your loan to compensate for the added risk. A very low credit score can mean you’re denied a loan.
Different than your credit score, a bankruptcy score measures the likelihood that you’ll file for bankruptcy within a certain period of time, usually 24 months. In a credit score, your lender is trying to understand the risk that you’ll miss a payment or two, and are likely to have your account end up in collection. With a bankruptcy score, your lender is trying to assess the risk that your account will be entirely uncollectible because you filed bankruptcy.
How is there a difference? In terms of customer behaviour, it’s quite a lot. A person who has a high risk of filing bankruptcy can actually have a good credit score. That’s because they have a lot of credit history (compared to someone seeking credit for the first time) and may not have missed any payments. However, there are flags that the bankruptcy score raises to advise the lender that you may be a risk in a different way. People who file for bankruptcy have a particular credit profile just before filing and this is what the bankruptcy score measures. Prior to filing bankruptcy, borrowers very often use a lot of credit. They have many new loans, especially credit cards and payday loans, but tend to have less accounts in collection. They have a very high utilization rate since most of their credit cards are maxed out.
How your credit is affected
All major credit bureaus have some version of a bankruptcy score. Your lender can access this score at the same time as they conduct a credit check when you apply for a loan. Even if you have a good credit score, if you have a high bankruptcy score, you may still be turned down for a loan or a credit card. Unfortunately, you may not know that your bankruptcy score was the reason for being turned down since you can’t get a free copy of your bankruptcy score like you can your credit score. If you’re turned down for a loan, ask your lender why. Find out what factors they considered put you at too high a lending risk and work to improve those before applying again.
To improve your bankruptcy score, you should do many of the same activities as you would to improve your credit score such as paying bills on time and keeping your credit utilization low. However, pay particular attention to making multiple new credit applications, having many credit card accounts with high balances, and moving money from one credit card to another rather than lowering your overall utilization rates.
What to do when you’re denied credit
This also means that if you’re avoiding bankruptcy because of the potential impact it may have on your credit score, your lender may be treating you like you’re bankrupt anyway by denying you more credit. Many people wait to file bankruptcy until the point when they can no longer get new credit to keep up with payments on old debt. If your debt balances are growing because interest costs are consuming too much of your income, it’s time to deal with the debt. Filing bankruptcy or a consumer proposal now starts the countdown to rebuilding your finances so you can rebuild your creditworthiness in the future.
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