Thursday, October 20, 2011

Too Much Information

Last year I wrote a blog about a practice that FICO had just rolled out to help banks determine the credit worthiness of their clientele based not only on their history of paying their bills, but on other factors as well.  

At that time, the Fair Isaac Company--creators and owners of the FICO score system that governs our lives--had announced a new system marketed to banks to track depositor behavior. The then new system assigns each bank client a score based on deposit and withdrawal activity. Presumably, checks for non-sufficient funds and returned checks count against the borrower's score. The scoring system alerts the bank when there is a change to the borrower's financial activity--for instance, a direct deposit which stops may signal the loss of a job. Using up the savings may also signal financial difficulties. And that can be the bank's cue to cut off credit.

In addition to tracking bank information, credit bureaus are also using income estimates to determine potential debt to income ratio. Although credit reporting agencies do not have direct access to income documents or to IRS-filed tax returns, the Federal Reserve has cleared the way for lenders to use credit bureaus' income estimates to determine whether a particular borrower would be creditworthy for credit cards and credit lines. Using existing credit lines and the type, balance, and age of the consumer's mortgage, the credit bureaus attempt to determine what the client's annual income is. His stated income on a credit application can then be cross checked against the credit bureau's guesstimate to see whether the numbers line up.

The banks are also tracking the consumer's home's value.  A WSJ article from 2010 tells of Ken Lin, who had a very good credit score but was denied for a credit card. He was flagged as high risk because he lives in California where his property value had declined but his mortgage balance had remained steady, signaling that he was on an interest-only mortgage. 
The cash value of bank accounts and other "liquid assets" can be an important mitigating factor in determining credit worthiness, but previously credit reports did not disclose financial liquidity just as they did not disclose income. Now, however, Experian offers a service which estimates financial liquidity for consumers so that the banks can use this information to determine credit worthiness.

For more than a decade, the importance of a good credit score has been drilled into us, with the result that many more Americans know their credit score and understand its impact on their lives.  And as a result, many Americans have tried hard to maintain their credit through the tough times of the past two years, knowing that a poor credit score has long on-going consequences. 

Now, as experts speculate about whether we are officially headed back into another recession, FICO has introduced yet another new set of perimeters for credit reports. On October 10, 2011, they announced a new initiative through CoreLogic which will provide lenders with still more info on prospective borrowers.

The new credit scoring models will include previously excluded items such as child support payments.  Right now, child support shows up on credit reports only if it goes into collection.  Regular payments do not appear on a credit report.  The system will also score apartment rentals and applications to payday lenders.

In FICO's press release about the new system, VP of scoring and analytics Greg Pelling said that, "Lenders today need as much actionable consumer information as possible so that they can safely grow origination volumes and avoid future losses."  And indeed, some analysts are saying that the new information will help people with thin credit files get approved for credit more easily because the models will allow lending institutions to take into consideration payment histories that currently do not report. This can mean that borrowers who have paid all of their bills on time but not utilized much "traditional" credit can have an easier time being approved.

But for most Americans, increased scrutiny into their financial lives is going to increasingly limit access to credit.  People who are struggling financially--particularly small business owners who are living on credit cards while trying to keep their businesses open--have increasingly seen their access to credit and capital cut off on the last few months.  Cutting off credit to people who are struggling may be a prudent move for a financial institution, but for the small business owner or the family trying to make ends meet, not being able to get credit in tough times may mean the difference between weathering the current financial storm and drowning.  At a time when falling home values and stringent underwriting guidelines are causing many otherwise qualified Americans to be locked out of the ability to refinance their homes to take advantage of historically low rates and lower their payments, should we really be adding in another level of scrutiny to make it still harder for people to qualify for loans?  As we continue to scrutinize every aspect of potential borrowers' financial lives, we can find more and more reasons to deny more and more people access to loans that could dramatically improve their financial situations.

It will be interesting to see how FICO compiles and processes the information obtained.  For example, traditional credit reports report borrowers who have been late 30 days on a payment as delinquent.  However, apartments and other housing rental agencies tend to consider payments made after 15 days delinquent.  Will FICO report delinquent payments on accounts not past due 30 days if that is how the reporting organization listed them? 

All of this new access to info just means that for the consumer who is beginning to have some financial problems--loss of equity in a home, loss of one of the household incomes, etc. the financial service provider can identify those persons and cut off their access to credit even if they have had a perfect pay history.  It is a little like the credit version of "Minority Report"; we can now determine whether a person is at risk to default and punish them before they have a chance to make their first late payment.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at http://www.frontier2000.net.

 

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