Bankruptcy and Open Chargeoffs–A Common But Unrecognized Problem

Statistics show that 3 out of 4 people struggle with serious financial problems for up to 3 years before filing. Most are regular citizens who, unfortunately and for whatever reason, find themselves with more debt than they can repay. They are embarrassed, depressed, scared, and angry about what is happening to them. While there are those that abuse the system, they tend to be the exception than the rule. As consumers emerge from bankruptcy many find numerous tradelines on their credit reports indicating bad debts or charge offs with balances owing. However, in reality the accounts were liquidated via administrative relief and should be updated to zero balances and shown as discharged in bankruptcy. The results of the recent PIRG study “Mistakes Do Happen: A Look at Errors in Consumer Credit Reports” touches on this issue, but just barely. We believe that the PIRG report understates the case of bankruptcy public record items and open charge-offs double dinging credit scores and that this is probably a widespread problem, or worse, that there may be a deliberate dynamic in play that is predatory.

Southern California has hundreds of thousands of filers and Springboard Non-Profit Consumer Credit Management has seen many credit report cases reflecting bankruptcy with open chargeoffs. Bankruptcy filers are naturally prospects for high-interest loans and although we cannot quantify this segment of consumers numerically, there appear to be a large number who have “double dinged” credit scores due to both the public record and the open charge-off remaining on the credit reports. The bankruptcy alone will cast the filer into an undesireable rate tier.

Credit bureaus are provided with the bankruptcy exhibits to assist with updating of the credit report, in turn they contact the creditors to facilitate the corrections. Consumers may have accounts appearing on their credit report(s) with balances long after these accounts were discharged in bankruptcy. Some accounts may not have been updated on the credit reports and indicate open balances and/or additional derogatory ratings. This misrepresentation of information may further negatively impact those reviewing the consumer’s credit report as well as their FICO score. The accounts that are not updated have the potential to re-punish the score further, as the public record/bankruptcy itself already impacts the score.

Relisting (updating) the accounts to reflect a zero balance and as discharged in bankruptcy will accurately update their report and usually raises the client’s credit score. The following may be some other “factors within factors” that lower a credit score when there has been inaccurate reporting of accounts discharged in bankruptcy:

  • Additional tradelines appearing as seriously delinquent
  • In collections
  • Number of accounts delinquent
  • High amounts owed on accounts (that were discharged)
  • Proportion of “balances” to credit limits on revolving accounts are high ( Another possible factor and inadvertent impact that should be studied is how much the “open chargeoff with balance” raises the “utilization” factor. Under the FICO model higher utilization makes a score go down )

When institutions do not update the charge-off balance as discharged it’s twice as devastating to the consumer’s credit rating and many consumers are unaware their credit score is being damaged even more by misrepresentation of bad debt discharged in bankruptcy. Note: “twice” is just an estimate – none of us are able to predict the exact mathematical impact in the FICO model.

Since so much in our lives depends upon our credit history, everybody has a big stake in making sure they are accurate. This situation can be common with creditors who stop working an account when a bankruptcy is filed but fail to update the tradeline when the bankruptcy is actually discharged by the court. Without this update/re-listing the charge off (“9”) and/or high balances owing will hurt a credit score that is already damaged from the public record entry item that goes on the credit report. Without the update/re-list on the creditor tradeline portion of the credit report it appears that the debt was not included in the bankruptcy and/or that there is new bad credit after the bankruptcy (another kiss of death).

A debt discharged in bankruptcy would have to be charged off by the creditor as they have to write the debt off their books as uncollectable. To report the tradeline with a balance owing is misleading. The “charge-off with balances owing” part of the notation has to be deleted since the debt was discharged in bankruptcy. When a debt is discharged in bankruptcy, the updated credit reports display a narrative indicating the creditor’s name, account number, and “discharged in bankruptcy” with no “9” or balance owing. When this update/relist does not happen it may not be due to a credit bureau error but due to inaccurate reporting by the data furnisher.

Some creditors deliberately do not do this updating because: 1) they can still wrangle payments out of consumers who don’t know better, or 2) they deliberately want to cause as much damage as possible on the filer’s credit report. A third reason is undoubtedly just plain negligence on the part of data furnishers. For example, a consumer gets collection calls because filers have not been scrubbed from the lists of debtors that are sold all over the place to debt buyers – there’s a whole secondary market for charged off debt. No matter what the reason, it’s illegal and the public is largely unaware of what’s happening.

It is against the law (bankruptcy code) for creditors to collect on debts discharged in bankruptcy, however, without the update by the creditor on their internal records and/or recalling accounts that have been sent to collection and/or on the credit reports, there are situations where consumers have unknowingly had their credit scores punished further and who have even paid a debt that was already discharged in bankruptcy just to clear up a balance so they can get a mortgage loan.

One might ask: “why focus on this issue since having just the bankruptcy on one’s record will prevent you from getting any sort of loan?” This is no longer true. There are mortgage loan programs out there for people one year out of bankruptcy (e.g., the Freddie-backed Lease Purchase Program), so inaccurate post-bankruptcy reporting can make a difference. In the case of the Freddie program, one can enter the program just one year out of bankruptcy, but you have to have a score of 620 after a certain amount of time.

Summary: Our experience shows that post-bankruptcy reporting errors and snafus are common. Bankruptcy attorneys will validate this too. When institutions do not update the charge off balance as discharged it’s twice as devastating to the consumer’s credit rating. Many consumers are unaware their credit score is being further damaged by misrepresentation of bad debt discharged in bankruptcy.

Credit.org was formerly known as Springboard Nonprofit Consumer Credit Management Inc.