Disaster # 2 - Credit Destruction

Part 2 of a series: Avoiding Disastrous Debt Interactions

Recent events have caused us to re-examine the potential for bias, not only with the police, but all institutions in society, including the credit and collections apparatus to which you and I belong. While we try to operate fairly and in the customer’s interest, we also have the power to cause harm.

Last week, I wrote about unnecessarily losing customers as a side effect of insensitive collections. Now, I’ll discuss an aspect that places the pain more squarely on the consumer’s side: destroying their credit.

In the 2008-9 Great Recession, 50 million Americans had a drop of at least 20 points in their FICO score, with 21 million dropping over 50 points.* For the economy, falling scores represent credit destruction – taking billions of dollars in buying power out of the consumer’s pocket and slowing economic recovery.

Think of millions of consumers not qualifying for a mortgage, a quality apartment, a conventional car loan or just a few hundred dollars of open-to-buy to replace a worn-out appliance. 

Even when someone can borrow, being labeled “subprime” not only subjects a consumer to sky-high interest, but a litany of indignities, among them using a “Buy Here, Pay Here” auto dealership that can remotely disable your car if you miss a payment.

Subprime dealers use devices like this one to disable a car when the owner misses a payment.

 (If you’ve never heard of this practice, see https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2018/11/27/late-payment-a-kill-switch-can-strand-you-and-your-car)

 It doesn’t take too much imagination to see that the pain of credit destruction falls disproportionately on the shoulders of poor and minority communities. 

Some will probably be asking at this point: “So what can we do about it? After all, it’s not our fault the consumer got too deep into debt. And, even if it’s just bad luck, you can’t pin the blame on us for something like Covid-19!”

No, we can’t take blame for consumer behavior, or for pandemics, but we can promote interventions that prevent credit score declines.  For example:

• Identify current but “at risk” accounts – e.g. high credit line utilization and minimum payments –and offer proactive incentives to accelerate pay down of the account.

• Immediately contact customers after the first missed due date, to gain a minimum payment before a delinquency is reported to credit bureaus.

• Educate borrowers about credit-sparing debt solutions. For example, using a debt management plan (DMP) from a non-profit credit counselor will cause far less credit damage vs. the for-profit “settlement mills” (These are the companies that advertise “It’s your right to settle for less than you owe.”)

In a DMP, the counselor arranges a repayment plan with creditors at a reduced interest rate, speeding the balance payoff. The flip-side is that the DMP usually requires credit card accounts to be closed, hurting buying power and potentially lowering a consumer’s credit score – but not by nearly so much as the typical “settlement mill” solution of withholding payments for several months, seeking a cents-on-the-dollar settlement with the creditor.

As an alternative, I suggest a “DMP-lite” approach in which the account stays open but is temporarily frozen against making new charges, while the debtor pays down the balance at a reduced interest rate. In fact, in the Covid-19 economy, I advocate that lenders be quicker to lower APRs for everyone. After all, the cost of funds is near zero.

But, while settlement mills spend many millions advertising their solution, non-profit debt counselors and the lenders themselves do not. As a result, few consumers have even heard of a DMP, while practically everyone’s heard the deceptive claim that “You have the right to settle for less than you owe.”

It’s in the interest of consumers, and – in the long-term, creditors – to more widely promote credit-sparing debt solutions.

* https://www.washingtonpost.com/realestate/as-consumer-credit-scores-plunged-in-2008-2009-lenders-raised-their-standards/2011/12/28/gIQAqjCBhP_story.html