Last January I talked about new technologies introduced at Equifax Canada to enhance the consumer’s credit profile, and subsequently reduce the lender’s risk. Based on “trended credit data,” the technology looks at payment patterns to predict future delinquencies.
This may sound intuitive, but studies have confirmed the conventional wisdom that transactors – those consumers who pay off their entire balance each month – are better risks than revolvers – consumers who only pay a portion of their balance each month. But it is the quantification of this intuition that matters. Just as importantly, studies 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 all credit product types.
Both credit agencies, Equifax and TransUnion, are now using Total Payment Ratio (TPR) to measure the chance of delinquency. Simply put, TPR is calculated by dividing a consumer’s total monthly credit card payments by the total minimum due on all credit cards. For example, a person making $1,200 in payments on three credit cards when the aggregate minimum due on those cards was $600 would have a TPR of 2.0. A person making $1,200 in payments with an aggregate minimum due of $200 would have a TPR of 6.0. Studies clearly demonstrated that as the TPR increased, delinquency levels decreased on credit cards, auto loans and mortgages.
TransUnion also developed a metric called the Aggregate Excess Payment (AEP) to better gauge how many dollars in excess of the minimum payment were made. This variable is 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. For example, 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 their AEP would only be $100. Not surprisingly, the AEP variable also performed quite well as a risk splitter across credit products.
The new metrics are good news for consumers, particularly those who only pay off portions of their credit cards each month. If you can’t pay the full balance, at least now lenders may view you in a more positive light depending on the amount you do pay.
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