Delinquencies

What Is Delinquency?

Delinquency, in finance, refers to the failure to make a required payment on a loan or other financial obligation by the agreed-upon due date. It is a critical concept within credit risk management and is closely monitored by lenders, financial institutions, and credit bureaus as it signals potential financial distress on the part of the borrower. Delinquency is the initial stage of a payment default, occurring when a payment is past due but has not yet reached the point of being charged off as uncollectible.

History and Origin

The concept of debt and its collection is as old as civilization itself, with records tracing back to ancient Sumer in 3000 BC, where debtors unable to pay could become debt slaves⁵¹, ⁵². In the Middle Ages, legal systems emerged in Europe that allowed creditors to take debtors to court, often resulting in bailiffs seizing goods or debtors being sent to "debtor's prison" until the debt was settled⁴⁹, ⁵⁰.

Modern consumer credit, as a widespread phenomenon, began to take shape in the early 20th century in the United States, transforming household finance from a disorganized system into a more regulated and promoted one⁴⁷, ⁴⁸. Early forms of installment plans and charge accounts in department stores laid the groundwork for today's revolving credit⁴⁵, ⁴⁶. As consumer credit expanded, the need for standardized assessment of creditworthiness arose. The first credit bureaus emerged in the 1950s, collecting individuals' credit histories⁴³, ⁴⁴. A significant milestone was the founding of Fair, Isaac and Company (FICO) in 1956, which developed a statistical model to predict the likelihood of a borrower defaulting⁴². The FICO score, introduced in 1989, became an industry standard for assessing [credit risk] (https://diversification.com/term/credit-risk) and predicting future delinquency⁴⁰, ⁴¹.

Legislation also played a crucial role in shaping debt collection practices. The Fair Debt Collection Practices Act (FDCPA), signed into law in 1977, was a significant step in regulating debt collectors and limiting harassment³⁹. The Consumer Credit Protection Act of 1968, along with subsequent amendments like the Fair Credit Reporting Act (1970), aimed to increase transparency in credit markets and protect consumers' rights regarding their credit information³⁶, ³⁷, ³⁸.

Key Takeaways

• Delinquency is the failure to make a timely payment on a financial obligation.
• It serves as an early indicator of a borrower's potential financial instability and can precede a default.
• Lenders use delinquency data to assess borrower risk and determine creditworthiness.
• Delinquency impacts a borrower's credit score and can lead to higher interest rates on future borrowing.
• Monitoring aggregate delinquency rates can provide insights into the overall health of the economy.

Formula and Calculation

While there isn't a single universal formula for "delinquency" itself, as it's a state rather than a calculation, financial institutions and regulators track delinquency rates using various metrics. These rates are typically expressed as a percentage of outstanding loans or accounts that are past due.

For instance, a common way to calculate a delinquency rate for a portfolio of loans is:

Alternatively, it can be calculated based on the number of accounts:

The definition of "delinquent" often varies by the number of days a payment is late (e.g., 30-day, 60-day, 90-day delinquency). For example, the Consumer Financial Protection Bureau (CFPB) defines delinquency as beginning on the date an amount sufficient to cover a periodic payment becomes due and unpaid³⁵.

These calculations help in assessing the asset quality of a lender's portfolio.

Interpreting Delinquency

Interpreting delinquency involves understanding its severity and its implications for both individual borrowers and the broader economy. Delinquency is often categorized by its duration, such as 30-day, 60-day, 90-day, or 120-day past due, with longer periods indicating more severe financial distress. A 30-day delinquency is considered an early-stage indicator, while a 90-day delinquency typically signifies a serious delinquency³⁴.

For an individual, a single delinquency can negatively impact their credit report and subsequently their credit score. Repeated or prolonged delinquencies can significantly lower a credit score, making it harder to obtain new loans or credit at favorable terms in the future³³. Lenders view delinquencies as an increased risk and may charge higher interest rates to compensate³².

At a macroeconomic level, rising aggregate delinquency rates across various loan types (e.g., mortgages, auto loans, credit cards) can signal a weakening economy or increased household debt vulnerability. The Federal Reserve, for instance, monitors consumer credit delinquency rates as an indicator of household financial health³⁰, ³¹. Increases in delinquency rates, especially across different income levels, can indicate economy-wide pressure²⁹.

Hypothetical Example

Consider Sarah, who has a personal loan with a monthly payment of $200 due on the first of each month.

• Scenario 1: 30-day Delinquency

  • Sarah fails to make her payment on August 1st.
  • By August 31st, her payment is 30 days past due. Her loan is now considered 30-day delinquent. This will likely be reported to credit bureaus, affecting her creditworthiness. The lender might also charge a late fee.

• Scenario 2: 60-day Delinquency

  • Sarah misses her August 1st payment and also her September 1st payment.
  • By September 30th, she is 60 days past due on her August payment. Her loan is now 60-day delinquent, indicating a more serious situation for the lender. This will further negatively impact her payment history.

• Scenario 3: 90-day Delinquency

  • Sarah misses her August, September, and October 1st payments.
  • By October 30th, she is 90 days past due on her August payment. Her loan is now 90-day delinquent. At this stage, lenders often intensify collection efforts and may consider the loan to be in default. This severe delinquency can cause a significant drop in her credit score.

Practical Applications

Delinquency data is fundamental in several areas of finance:

• Credit Underwriting and Lending: Lenders extensively use delinquency history to assess the risk of new loan applicants. A strong history of on-time payments indicates lower risk, while past delinquencies raise concerns about a borrower's ability or willingness to repay²⁸. This influences the approval of loan applications, the interest rates offered, and the loan terms.
• Risk Management for Financial Institutions: Banks and other financial institutions continuously monitor delinquency rates across their loan portfolios to gauge their overall credit risk. High delinquency rates in specific loan types or regions can signal systemic issues, prompting institutions to adjust their lending strategies or increase loan loss provisions. The IMF's Global Financial Stability Report often highlights key credit risks, including those related to rising debt levels and potential delinquencies²⁵, ²⁶, ²⁷.
• Economic Indicators: Aggregate delinquency rates are key economic indicators. For example, the Federal Reserve Bank of New York regularly publishes data on household debt and delinquency rates for various consumer credit products, including mortgages, auto loans, and credit cards²⁴. Rising trends in these rates can suggest broader economic challenges, such as decreased consumer spending power or job losses²², ²³.
• Debt Collection and Recovery: Delinquency is the trigger for debt collection activities. Lenders and collection agencies implement various strategies, from reminder calls to legal action, to recover delinquent debts. Understanding the stage of delinquency helps tailor these efforts.
• Credit Scoring Models: Delinquency data is a primary input for credit scoring models like FICO and VantageScore. These models weigh payment history heavily, with delinquencies significantly impacting an individual's credit score²⁰, ²¹. Machine learning and deep learning techniques are increasingly used to predict credit delinquency risk¹⁵, ¹⁶, ¹⁷, ¹⁸, ¹⁹.

Limitations and Criticisms

While delinquency is a crucial metric, it has several limitations and faces criticisms:

• Lagging Indicator: Delinquency is often a lagging indicator of financial distress. It reflects a problem that has already occurred, rather than predicting it. By the time a payment is delinquent, the borrower may already be experiencing significant financial difficulty.
• Data Accuracy and Completeness: The accuracy and completeness of data reported to credit bureaus can be a concern. Errors in credit reports are not uncommon, which can unfairly impact a borrower's delinquency status and credit score¹³, ¹⁴. Not all lenders report to all credit bureaus, leading to discrepancies¹². Additionally, some alternative financial products and payment histories (like rent or utility payments) are not always captured by traditional credit scoring models, potentially underrepresenting a borrower's true financial behavior and leading to "credit invisible" populations¹¹.
• External Factors and Atypical Events: Delinquency rates can be significantly influenced by external factors such as economic recessions, natural disasters, or pandemics. During the COVID-19 pandemic, government interventions like forbearance programs temporarily impacted delinquency rates, making their interpretation more complex⁹, ¹⁰. Traditional credit risk models may struggle to account for such atypical events⁸.
• "Ability to Pay" vs. "Willingness to Pay": Delinquency records whether a payment was missed, but not why. It doesn't differentiate between a borrower who cannot pay due to job loss versus one who chooses not to pay due to a dispute or strategic default.
• Model Limitations: While advanced models are used to predict delinquency, they are not infallible. Some models may not adequately capture the causality of default or may overstate or understate risk depending on market volatility⁷. Data drift, where the characteristics of the input data change over time, can also lead to model degradation and inaccurate predictions of delinquency⁶.

Delinquency vs. Default

Delinquency and default are related but distinct terms in finance, representing different stages of a borrower's failure to meet their financial obligations.

While every default begins with a period of delinquency, not every delinquency leads to a default. Delinquency is a warning sign, whereas default represents a critical failure to repay.

FAQs

How does delinquency impact my credit score?

Delinquency negatively impacts your credit score because payment history is the most significant factor in credit scoring models⁵. Even a single late payment can cause your score to drop, and more frequent or severe delinquencies will have a greater negative effect. This can make it harder to qualify for new credit or result in higher interest rates.

What should I do if my account becomes delinquent?

If your account becomes delinquent, contact your lender immediately. Explain your situation and explore options such as a temporary payment arrangement, loan modification, or forbearance. Proactive communication can sometimes help mitigate the negative impact on your credit and avoid further penalties or a full default.

How long does delinquency stay on my credit report?

Most negative information related to delinquency, including late payments, generally remains on your credit report for up to seven years from the date of the original delinquency⁴. Bankruptcies can remain for up to 10 years. Even if you pay off the debt, the record of the delinquency will typically stay on your report for this period.

Is delinquency the same as bankruptcy?

No, delinquency is not the same as bankruptcy. Delinquency means a payment is overdue, while bankruptcy is a legal process for individuals or businesses who cannot repay their outstanding debts. Bankruptcy is a much more severe financial event with long-lasting consequences for your credit and assets.

How do lenders predict delinquency?

Lenders use sophisticated credit risk models that analyze a borrower's financial history, income, existing debt, and other factors to predict the likelihood of delinquency. These models often employ statistical techniques and increasingly, machine learning and artificial intelligence to identify patterns and assess risk¹, ², ³.