HOBOKEN, N.J. -- Consumer lenders need to prepare for the comingcrush of revolving debt defaults by adopting a new way to gaugerepayment capacity, according to the Filene Research Institute.

The Filene report released last week introduces a new conceptcalled "responsible debt relief," a program that offers an estimateof a consumer's ability to repay outstanding debt. Thereport--"Responsible Debt Relief: An Algorithmic Assessment ofHousehold Debt Capacity and Repayment Capability"--was written byRobert D. Manning, director of the Center for Consumer FinancialServices at the Rochester Institute of Technology.

The emergence and growth of near-bankrupt households with creditcard debts in the $40,000--$60,000 range underscores the need for apartial payment plan that balances the interests of creditors andconsumers without incurring costly debt collection litigation orbankruptcy filing fees, the report explains.

"A means-tested program is needed for these near-bankruptconsumers," said Manning.

"The key to a successful RDR system is the objective andstatistically precise estimate of consumer debt capacity and debtrepayment capability."

Unlike traditional debt collection grading assessments,Manning's system is based on a statistically complex andgeographically robust empirical algorithm. This generates twocrucially important evaluative assessments: classification ofindividual consumers into appropriate means-tested debt managementprograms and specific statistical estimates of consumers' debtcapacity and ability to repay outstanding unsecured debt.

"The RDR algorithm improves the efficiency of the overall systemof consumer debt management programs," said George Hofheimer,Filene's chief research officer, "by guiding consumers to the plansthat best match their financial situations. The program offers awin-win proposition to lenders and financially distressedborrowers."

Many financially distressed households that do not qualify foran accredited consumer credit counseling service program enroll indebt settlement programs, while others simply give up by filing forbankruptcy in a last-gasp effort to save their homes or to seekprotection from the stress of debt collection. Manning said thatmortgage debt figures are especially important, since many Americanfamilies have relied upon their home's equity to finance householdexpenses and are getting hit with rising credit card balances andrates.

The recent emergence and growth of heavily indebtednear-bankrupt households (those with credit card debts in the$40,000--$60,000 range) underscores the need for a partial paymentplan that balances the interests of creditors and consumers withoutincurring costly debt collection litigation or bankruptcy filingfees, Manning added.

"A means-tested program is needed for near- bankrupt consumerswho do not have sufficient resources to enter a consumer creditcounseling service debt management program but possess enough cashflow to repay a portion of their unsecured debts, even though theycould file for consumer bankruptcy," the report said.

Manning believes that his program counters the lack of anobjective, empirical algorithm that precisely estimates therepayment capability of consumers and that explicitly recognizesdifferences in cost of living, household structure and after-taxincome.

"Clearly, both creditors and consumers would benefit from anegotiated repayment program that offered near-bankrupt householdsthe option of repaying between 20% and 60% of their unsecured debtsover three years," he said.

The first component of the RDR assessment distinguishes "worthy"from "unworthy" debtors by identifying those households thatqualify for a debt relief concession from lenders. The RDRalgorithm classifies consumers into three distinct categories ofdebt repayment capability:

Low--Chapter 7 bankruptcy is the most realistic option (thedebtor can repay only a small fraction of their unsecureddebts).

Medium--The debtor's estimated after-tax income qualifies forsubstantial debt concession (the debtor can repay 20% to 60% ofunsecured debt over three years).

High--The debtor can achieve full balance payment through anaccredited debt management program.

The second evaluation phase of the RDR assessment is astatistically precise, means-tested validation of an individual'sneed for a specific debt concession in order to avoid filing forpersonal bankruptcy.

Although the RDR algorithm estimates--in percentage terms--thecapability of all applicants to repay their unsecured debts, onlythose consumers eligible to file for consumer bankruptcy areconsidered for what Manning calls the "Responsible Choice"program.

"The most financially distressed consumers who cannot repay aminimum of 20% of their unsecured debts do not qualify for theResponsible Choice program and are referred to consumer bankruptcyprofessionals." Similarly, consumers who are able to repay morethan 60% of their unsecured debts over three years are referred toa consumer credit counseling program. "Only those consumers who canrepay between 20% and 60% of their unsecured debts over three yearsqualify for a consumer debt relief concession of the ResponsibleChoice program," explained Manning.

For creditors, he added, the precision of the RDR grading systemensures that only the most worthy financially distressed householdsare qualified for consumer debt relief. The Responsible Choice planspecifies, moreover, that the costs of administering the programare paid by those who are fortunate enough to receive debtconcessions. Lenders do not incur any collection-related expenses,which maximizes the net return on their delinquent accounts.

Credit unions interested in piloting the Responsible Choiceservice are invited to contact Manning [email protected].

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