Wednesday, July 09, 2008

What You Buy Can Hurt Your Credit

In its June 30 issue, Business Week published a piece about how some credit card companies are monitoring what customers are purchasing, and in some cases reducing their credit lines accordingly. This type of practice came to light in a recent FTC complaint against Compucredit Corporation for unfair practices. If you want to read about some pretty incredible predatory lending practices, I highly suggest you read that complaint - 44 pages of double spaced, highly readable, credit card horror stories. Wow.

Anyway, the topic of this post is one specific lending practice that Compucredit allegedly followed. Here is a direct quote from the complaint (page 34):

"CompuCredit has based these credit line reductions on an undisclosed "behavioral" scoring model that penalized consumers for using their cards for certain types of transactions, including transactions touted in their solicitation materials such as cash advances and transactions with the following types of merchants:

  • Direct marketing merchants
  • Marriage counselors
  • Personal counselors
  • Automobile tire retreading and repair shops
  • Bars and night clubs
  • Pool and billiard establishments
  • Pawn shops
  • Massage parlors.

76. In some instances, CompuCredit reduced subscribers’ credit limits to levels below their existing balances and then charged over-limit fees."

Emphasis on the last sentence is mine. I want to talk about these practices on two levels. One is the high-level business practices type of analysis. The other is the actual approach that was taken. First, let's talk about this business practice in principle. Generally speaking I think that looking at behavioral data, including purchasing data, to make credit allocation decisions is not a bad idea. If someone is shown to be a bad credit risk by their very purchasing activities, should the lender be forced to keep throwing good money after bad?

Let's look at a couple of the specific examples given: marital counselors - if someone is going through some marital issues, which may or may not result in divorce and financial hardship, I think it is very reasonable to consider them a higher credit risk. The same can probably be said for pawn shops. I am guessing that few people in good financial standing frequent these establishments, and in any case, there is probably a correlation between people who patronize pawn shops and people whose financial situation is less than stellar... So, in principle, if I was running a credit card company I would certainly want to consider factors that would increase my credit risk - including the types of establishments my customers were spending my money at...

Of course, this brings us to such questions as consumer privacy and adequate disclosure. As an avid free market capitalist, I am a strong believer that knowledge is the best form of regulation. For example, once the government forced food manufacturers to disclose the trans fat content of their food, this harmful ingredient quickly disappeared from many products available on the market. If customers are clearly told that their purchasing behavior is a criteria for the level of credit they receive, and they still choose to apply for the credit card, I have no problem with this practice. In principle, at least.

Now let's talk about the specific practice. The ability of credit card companies to lower the credit line after a purchase has already been made, such that the new credit limit is lower than the outstanding balance, is preposterous. The fact that companies are then able to charge their customers an "over the limit" fee is both ludicrous and criminal. This only works in the credit card industry. Can you imagine a situation where a car dealer would be able to increase the selling price of a vehicle three months after you bought it? What if the person selling you a house was able to change his mind about leaving behind his appliances after the deal had already closed and you moved in? How are these examples any different from the credit card company changing your credit line such that you are then forced to immediately re-pay money you don't have?

Congress, the FTC, or whoever is in charge should quickly correct this situation. Credit card companies should be able to make changes that apply to future credit decisions, but never to balances that are already outstanding. Want to change the interest rate? Fine, your decision only applies to future purchases, not to ones that have already been made. Want to reduce the credit line? No problem, so long as it is not below the outstanding balance at any given time.

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