Study says bankruptcy can bring more loans

By Michael McKee
Bloomberg News / April 16, 2009
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NEW YORK - Personal bankruptcy may increase the amount of revolving credit, such as credit cards, that debtors can access, according to a study by economists at the Federal Reserve Bank of Boston.

It found that those who are poor and have low credit scores are quickly able to borrow again, and frequently end up with higher loan limits.

The results run counter to a widespread and long-held assumption that bankruptcy punishes debtors by cutting off access to credit for some period of time, the authors said. The study found 90 percent of individuals have access to some sort of credit within 18 months of filing for bankruptcy protection, and a quarter of those get more credit.

"Individuals who are effectively the least punished and can get the easiest access to credit afterwards tend to be the ones who have shown the least ability and propensity to repay their debts," the study said.

The recession has produced a surge in bankruptcy cases. Personal bankruptcy filings rose 41 percent nationwide in March from the same period a year earlier, according to the National Bankruptcy Research Center.

The Fed study's authors said the findings suggest lenders are targeting at-risk individuals. Those borrowers are more likely to have gone bankrupt due to minor or temporary changes in their ability to repay than more creditworthy customers, who may have experienced a significant financial shock.

"Lenders have no incentive to reduce borrowers' credit limit unless bankruptcy reveals a change in a borrower's likelihood of repayment in the future," they said. "It remains relatively constant for borrowers who've always been at the low end of the credit quality spectrum."

The authors cite previous research that suggests lenders can profit by charging high interest rates and large fees, trapping consumers in a cycle of ever-higher payments often financed by additional borrowing.