Friday, January 20, 2006

It's what we don't know that hurts us!

This secret score can hurt your credit

A credit score looks mainly at your history of paying bills, but a ‘bankruptcy risk score’ looks ahead at how likely you are to file -- and lenders are paying attention. You probably already know about your credit score. That's the number that helped increase your credit card limit or perhaps prevented you from purchasing your dream car. Well, there's another influential scoring tool you should know about:

It's called the bankruptcy risk score.

According to financial experts, this score is used secondarily to the credit score when financial institutions scrutinize a consumer's credit history. Kept tucked away from consumers for nearly 20 years, this number differs from the credit risk score, because it's a little more specific. It measures how likely a person is to file for bankruptcy.It is used by credit reporting agencies and geared specifically to lenders.Researchers say the score typically surfaces when a consumer gives the bank permission to pull his credit report during the application process for a new loan, bank card or credit card, and during the periodic review of clients' accounts to determine whether to increase a consumer's credit limit.

Karen Gross, director of the New York Law School Economic Literacy Coalition, believes some lending institutions are using the score for their own compliance risk."Banks are required, by law, to keep a reserve based on potential bad debt losses," she says."In other words, to ensure the solvency of our lending institutions, we require that they maintain a certain capital-to-risk ratio. Bankruptcy scores give banks a more finely tuned instrument by which to assess true risk within their portfolio. As such, the bankruptcy scores could enable lenders potentially to lower their bad debt reserves because they can more accurately assess and hence narrow potential risk."

Aim for a low score

Credit reporting agencies weren't the only ones dabbling in this innovative approach.Researchers say a few credit card companies in the late '90s developed a means to make the score a more powerful tool based on a combination of factors, including information that was right in front of them: consumers' spending habits and types of charges."They could see that level of granular detail. So what they tried to do is combine credit bureau information and transactions to get a better idea," says Mike Staten, director of the Credit Research Center at Georgetown University in Washington D.C. "They would use that and make the score available and even go as far as sending to issuers, that subscribe to their service, specific alerts when a person exhibits warning signs of higher bankruptcy risk."

Analysts at credit reporting agencies say advanced mathematics and data analytics are used to determine the complex score.However, they say, some variables come directly from your credit report, such as how the credit is used, how often a bill payment is late and the number of inquiries made."For a conventional credit score, you want a high number," Gross says. "For a bankruptcy score you want a low number. And to increase the complexity, the range of the numbers is not the same. The credit score has a range of 350-850. The bankruptcy score range starts in the negative numbers and increases to possibly 2,000."

Ready to go public?

Why is it kept from the public? "The argument is that people spent time and money researching the scoring model, and no one wants to disclose the model because they are giving away the value of the research that they've conducted," says Gross.However, Experian is considering making its score available to consumers."We feel that it may help consumers if they are getting in trouble with their debt," says Samah Haggag, manager of analytics at Experian.

A July study by Experian is giving consumers some insight. The study ranked the states with the highest propensity to have consumers file for bankruptcy within the next year. The top five are:· Texas· Nevada· New Mexico· Louisiana· Arizona

Economist Mark Lauritano, of Global Insight in Massachusetts, says from a broad economic view you can see the reasons why Texas would be at the top of the list."Based on studies we've done: It's a relatively young state, people are moving to Texas, there's a lot of immigration from south of the border, it has a below-average income and it has a relatively low homeownership rate," says Lauritano.The things that improve your bankruptcy risk score are the same ones that improve your credit score: Pay your bills on time and apply for credit sparingly.

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