Study Quantifies How Credit Card Repayment Affects Risk
Credit cardholders who routinely pay only their monthly minimums present double the credit risk as those who pay more, even if only slightly more, according to a new study.
TransUnion, one of three national credit analytic firms, conducted the Credit Card Payment Study.
The study also confirmed the conventional wisdom that transactors—consumers who pay off their entire balance each month—are better risks than revolvers, who only pay a portion of their balance.
Just as importantly, the study revealed that not all revolvers are equal. Those who pay more than the minimum on their credit cards, even if they don’t pay off the full balance, present less risk across product types, said Ezra Becker, the firm’s vice president of research and consulting and co-author of the study.
“Our findings are good news for consumers, particularly those who only pay off portions of their credit cards each month,” he said. “Even if they can’t pay the full balance, they may now find that lenders view them in a more positive light depending on the amount they do pay.”
Becker said the real point of the research was to start looking more closely into the differences between transactors and revolvers.
TransUnion also wanted to discover and document patterns among those who make higher payments and to quantify the impact of those payments, he said.
Becker explained that research on its own data sets allowed TransUnion to show that of those consumers making payments on their credit cards, 40% will pay their entire balance while 60% will pay somewhat less. Of that 60%, 20% will pay only their card minimum. The minimum payers represent a significant additional risk of default, as the research has already shown, Becker said, but TransUnion found that consumers who make additional payments had significant differences.
As a result, TransUnion developed a new data point, the total payment ratio, which is found by dividing a consumer’s total monthly credit card payment by the total minimum due on their cards.
For example, a consumer who made $1,200 in card payments on cards that have minimum payments of $600 would have a TPR of 2.0. A consumer who had minimum payments of $600 and paid $900 would have a TPR of 1.5.
Becker said the TPR has proven to be an important metric because TransUnion found that as the ratio increased, delinquency levels dropped on all loans types and the TPR levels occasionally trumped credit scores.
“In some cases, individuals with lower credit scores but higher TPR levels outperformed those with higher credit scores but lower TPR levels,” he said.
To illustrate further, TransUnion found that consumers with a TPR lower than 1.03 had a 60-day delinquency rate of 1.98%, whereas those with a TPR higher than 3.0 had a delinquency rate of only 0.43%.
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TransUnion also developed a metric called the aggregate excess payment to better gauge how many dollars in excess of the minimum payment were made. This variable was calculated by subtracting the total minimum due from the total payments made across all of a consumer’s credit cards.
Two consumers with a TPR of 2.0 could have much different AEP profiles, TransUnion discovered. For instance, a consumer making $2,000 in payments with a total minimum due of $1,000 would have a TPR of 2.0 and an AEP of $1,000. A consumer making $200 in payments when the total minimum due was $100 also would have a TPR of 2.0, but his or her AEP would be $100.
“The AEP variable also performed quite well as a risk splitter across credit products, even when controlling for traditional credit score,” Becker said. “Having more than one metric to understand payment behavior provides flexibility to lenders in managing their risks and engaging their customers and prospects.”
At a time when understanding the ability to pay is so important, TransUnion found that these insights can be hugely worthwhile for lenders, Becker noted.
Credit unions and other financial institutions could potentially use the information to better understand their risk modules, said Fred Ryerse, senior vice president of lending for the $2.4 billion Members 1st Federal Credit Union in Harrisburg, Pa.
Ryerse, who said he has advised TransUnion about its research priorities in the past, said this development will enable his credit union to better understand some of the nuances in credit scoring and to tailor loan pricing accordingly.
An auto loan applicant with a credit score of 700 who has a history of making only minimum payments on his cards might receive a lower credit limit or pay a somewhat higher interest rate than an auto loan applicant with a base credit score of 690 but a TPR of 2.0, Ryerse said.
This additional data could end up developing a hard or soft credit score, he said. A credit score with a high TPR could be seen as a hard score because the consumer’s payment behavior suggests higher or lower delinquency. A consumer who has a 720 FICO score because of credit line utilization and other factors might still have a very low TPR or no TPR. This would signal that they might be riskier, Ryerse said.
The same data could also be used as an early warning should a member begin to get into trouble financially, Ryerse observed. A member with a long history of TPR at 1.3, who was only making minimum payments, might get a call to determine what happened and whether the credit union could help overcome some financial difficulty.
Ryerse said he expects Members 1st to begin using the enhanced TransUnion data sometime in 2014 after any possible technical and data problems are worked out. The credit union would also have to see how the scores can be deployed in underwriting and pricing of different types of loans, he said.
“Whenever you introduce a new data stream into the underwriting process, you always have technical questions about how the numbers will be made available on the screens and how to include them in the underwriting processes,” Ryerse said.