Federal Reserve Study Defends the Methods Used by Credit Card Issuers
The Federal Reserve has just released a new study that affirms the solicitation and lending practices of credit card issuers. The study is part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 that requires the Federal Reserve to report to Congress about the methods used by credit card issuers, and to determine if the industry's practices encourage consumers to accumulate additional debt. The review found that credit card issuers adequately assess the customer's risk, ability, and willingness to pay before offering credit.
The study offers interesting statistics about household debt:
* Households with credit cards have increased from 16% in 1970, to 71% in 2004.
* 46.2% of all households carry a credit card balance.
* 76.4% of all households have any type of debt. Most households carry debt regardless of age, race, ethnicity, net worth and work-force status.
* 8.9% of all families have a payment past due (60 days or more on any debt). 13.8% of families with an annual income of $20,000-$39,900 have a payment past due.
How Issuers Determine Credit Card Offers
The report says that issuers have become sophisticated with their process to forecast the ability and willingness of borrowers to repay their debts. Using detailed information from credit reporting agencies and proprietary databases, issuers use quantitative modeling to help them decide who they will extend credit to and what the price will be. Potential borrowers are ranked on the basis of historical information about borrowers with similar quantifiable characteristics. The Federal Reserve says these scoring models can "enable an efficient review of large numbers of customers, and form the basis of most credit decisions in the credit card industry."
The variety of card offers not only provides choices for consumers, but they allow the creditor to create products and incentives for specific segments of the market and to price them in a way that reflects the underlying risk of each segment.
While it seems that credit card issuers send offers to anyone with a mailbox, the issuers actually prescreen who they send solicitations to. They establish specific criteria such as credit score or account usage (number or credit cards already held and outstanding balances). Credit scoring agencies help provide information on customers in their database who meet the criteria. Prescreening allows creditors
to avoid the cost of sending solicitations to large numbers of consumers who would not qualify for the products offered.
Issuers use a number of factors during the application process, including credit history, debt burden, employment and income status, length of employment, and mortgage or rental history.They use this information to calculate debt to income rations to predict the consumer's ability to pay.
The study also described "work out" or "forbearance programs" which helps cardholders meet contractual obligations while minimizing credit loss to issuers. Despite the money made from interest, the issuers do want to receive the principal over a reasonable period of time, typically sixty months. The report says that "to meet these time frames, institutions may sometimes need to substantially reduce
or eliminate the interest rate or the fees so that more of the payment is applied to reduce the principal. In addition, institutions sometimes negotiate settlement agreements with borrowers who are unable to service their unsecured open-end credit."
The study also shows that while direct mail solicitations is the industry's most effective method for generating new accounts, it is not as effective as it used to be. In 2004, 5.23 billion solicitations were mailed, but the response rate was .4%, a record low.
"Even though the response rate is dropping, don't expect an end to the solicitations in your mailbox. 70% of the new accounts come from direct mail," says Bill Hardekopf, CEO of LowCards.com.
The study offers interesting statistics about household debt:
* Households with credit cards have increased from 16% in 1970, to 71% in 2004.
* 46.2% of all households carry a credit card balance.
* 76.4% of all households have any type of debt. Most households carry debt regardless of age, race, ethnicity, net worth and work-force status.
* 8.9% of all families have a payment past due (60 days or more on any debt). 13.8% of families with an annual income of $20,000-$39,900 have a payment past due.
How Issuers Determine Credit Card Offers
The report says that issuers have become sophisticated with their process to forecast the ability and willingness of borrowers to repay their debts. Using detailed information from credit reporting agencies and proprietary databases, issuers use quantitative modeling to help them decide who they will extend credit to and what the price will be. Potential borrowers are ranked on the basis of historical information about borrowers with similar quantifiable characteristics. The Federal Reserve says these scoring models can "enable an efficient review of large numbers of customers, and form the basis of most credit decisions in the credit card industry."
The variety of card offers not only provides choices for consumers, but they allow the creditor to create products and incentives for specific segments of the market and to price them in a way that reflects the underlying risk of each segment.
While it seems that credit card issuers send offers to anyone with a mailbox, the issuers actually prescreen who they send solicitations to. They establish specific criteria such as credit score or account usage (number or credit cards already held and outstanding balances). Credit scoring agencies help provide information on customers in their database who meet the criteria. Prescreening allows creditors
to avoid the cost of sending solicitations to large numbers of consumers who would not qualify for the products offered.
Issuers use a number of factors during the application process, including credit history, debt burden, employment and income status, length of employment, and mortgage or rental history.They use this information to calculate debt to income rations to predict the consumer's ability to pay.
The study also described "work out" or "forbearance programs" which helps cardholders meet contractual obligations while minimizing credit loss to issuers. Despite the money made from interest, the issuers do want to receive the principal over a reasonable period of time, typically sixty months. The report says that "to meet these time frames, institutions may sometimes need to substantially reduce
or eliminate the interest rate or the fees so that more of the payment is applied to reduce the principal. In addition, institutions sometimes negotiate settlement agreements with borrowers who are unable to service their unsecured open-end credit."
The study also shows that while direct mail solicitations is the industry's most effective method for generating new accounts, it is not as effective as it used to be. In 2004, 5.23 billion solicitations were mailed, but the response rate was .4%, a record low.
"Even though the response rate is dropping, don't expect an end to the solicitations in your mailbox. 70% of the new accounts come from direct mail," says Bill Hardekopf, CEO of LowCards.com.
Posted by Lynn at
11:14 PM
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