I often tell clients that banks don’t care if you pay your creditors. What? How can that be? I thought credit scores and paying your creditors was the most important thing to banks when they look at the decision to either lend you money or not. Turns out, that is not always true. Let’s look at a case study to illustrate the point.
Meet Sam & Lisa from Maple Grove
I met with Sam and Lisa, a nice couple from Maple Grove, Minnesota. When I met with Sam and Lisa, here is what they told me: Sam and Lisa make 110k a year and have two kids and live in a modest home in Maple Grove. They have 50k in credit card debt and they both have credit scores above 750, a really good credit score by anyone’s assessment. As is the case with many of my clients, they are current on all of their credit card payments.
Feeling some financial strain from making all of their credit card payments on time, Sam and Lisa decide to contact a major bank to see if they could get a loan to consolidate their credit card debt and lower their interest rate, and thus lower their payment. Makes good sense right?
They make the application for the loan and wait. As they see it, getting a loan should be easy since it will lower there monthly payment and their credit score is awesome! A few days later, in the mail, they received a denial letter from the bank. What? Why in the world can this couple not get a loan when their credit score is excellent and they are current on all of their credit card payments? I thought banks liked high credit scores and when applicants are current on their loan payments, right?
The Bank Wants to Get Paid
However, the bank doesn’t always see it that way. All things being equal, the bank wants to make damn sure that the bank does not lose money when they lend money. Presumably, when the bank looked at Sam and Lisa’s debts, what they worried about the most, was the bank was worried they would be the straw that breaks the camels back. They worried that if they lent Sam and Lisa money, they may not be able to make the payment on the loan and the bank would lose money.
The strange thing is this- if Sam and Lisa didn’t have the debt on the credit cards, the bank would likely lend them money. Why? Because without debt, the bank would be reasonably assured that they would get repaid. Heck, if you have no other debt, and you can’t file a bankruptcy again for 8 years, the bank is feeling more confident than ever about getting repaid. Truth is stranger than fiction!
The Advantage Of BANKRUPTCY
So, why are Sam and Lisa in my office, a bankruptcy attorney in maple grove's office? Because without consolidating these loans, they knew they would have problems making ongoing payments. This is one of the Top 5 Reasons Minnesotan's File Bankruptcy. When the bank turned down their loan request, they were forced into looking at what their bankruptcy options are.
When I looked over their options, they decided that doing a bankruptcy makes sense to them. The debt would be wiped out forever, tax free! So many of my clients want to fully repay their debts- their first choice is not to file bankruptcy- it’s their last choice!
Strangely, thanks to bankruptcy and the constitution, when Sam and Lisa file a bankruptcy, and their credit card debts get discharged, forever, tax free, they become a better credit risk than they were before they filed the bankruptcy! What? Are you telling me that Sam and Lisa will be a better credit risk after they file a bankruptcy than before when they had a great credit score and were current on all their bills? YES!!!! Why? Because after the bankruptcy discharge, Sam and Lisa are debt free!
My wager is the same bank that would not lend money to Sam and Lisa before would now lend them money. Why? Because they HAVE NO DEBT!!! Weird uh? It is, but that is the way the world works.
Banks Don't Care if You File
My opinion is banks don’t care whether you pay your other creditors, they care are you going to pay the bank! It took me years to understand how this works. I have been doing bankruptcy work for 19 years and it took time for this notion to sink into my brain. Many of the clients I deal with find this concept to be so foreign. They often believe that great credit scores and timely payments are what banks love to see.
Thinking cynically is a sport for me- I am not sure I am proud of that, but it is the way I am wired to think. The next time you try and obtain a loan and you get turned away by the bank, ask yourself this question? Does the bank really care if I am current on my loan payments and have a great credit score, really?