Leading Indicators of Bankruptcy

Posted by Mike Smith :: May 9, 2008 @ 7:33 am

Bankruptcy might seem like the low point of personal finances, but it is something that can be detected and perhaps even prevented. Knowing the factors that suggest a bankruptcy is potentially in your future could help you to avoid such an experience.

A 2005 report by the American Bankruptcy Institute states that three variables – the financial obligations ratio, the credit card default rate, and the credit card charge-off rate – appear to correlate with, and lead, the consumer bankruptcy filing rate. In other words, the higher these three variables are, the more likely a bankruptcy will result.

The report defines the variables as follows:

Financial Obligations Ratio

The financial obligations ratio is a measure of a family’s debt burden. It divides a family’s housing expenses (rent or mortgage, real estate taxes and insurance), automobile expenses (monthly loan or lease payments) and consumer debt payment obligations by that family’s after-tax income.

Credit Card Delinquency Rate

The credit card delinquency rate measures the percentage of credit card debt outstanding that is more than 30 days past due.

Credit Card Charge-off Rate

The Credit Card Charge-off Rate measures the percentage of credit card debt that is more than 120 days past due.

These three factors are all covered by two topics which I often write about here on the Lending Club blog: living beyond your means and the negative influence of credit card debt. Reducing your financial obligations ratio can be accomplished by increasing your income, but the more probable method is to cut back on your expenses. Curtailing your spending to live within your means will reduce this ratio. The high interest rates of credit cards can quickly make even those living within their means more likely to fall behind on their payments. Borrowing money with a person-to-person loan to consolidate credit card debt is an excellent way to get back on track.

It should come as no surprise that reducing your credit card debt and other financial obligations will improve your financial situation. Knowing that these measures are also indicative of bankruptcy potential should add further incentive to track them and ensure that you keep them to a minimum.