Guess Who’s Looking At Your Income
|January 27, 2010||Posted by Roshawn Watson under Uncategorized||
By: Roshawn Watson
Many people refuse to disclose their incomes for privacy reasons; however, credit bureaus will now estimate our incomes to determine our eligibility for new cards, amongst other things.
Credit Card Act
This practice is part of the new Credit Card Act and will begin in February. The Federal Reserve wants credit card issuers to consider an applicant’s income or assets and current debts before approving credit. There is some flexibility in the legislation allowing card issuers to use “statistically sound” estimates of income and assets. Consequently, Transunion, Equifax, and Experian have been working on products that estimate our incomes using information in our credit reports, such as the size and age of our mortgages or the size of our credit limits.
Credit card companies that actually ask us our incomes before issuing cards will be able to cross-reference the information that we provide with the estimates that they generate. The purpose is stop offering new credit cards to people who have no ability to pay their debts. If effective, this will limit losses and risks for card issuers, as they continue to tighten credit worthiness criteria. However, the impact of the income estimates don’t stop there. Although the main use of the updated income estimates have been for marketing pre-approved credit cards or other consumer offers, there is increasing interesting in other applications of this information. For example, the income estimates may also be used to decide whether to increase a credit limit because the financial information on the credit card accounts may be non-existent or no longer accurate. Lenders may also use this information to determine a debt-to-income ratio to evaluate whether a potential borrower may be financially over-extended.
Arising Concerns With The Changes
There are many concerns arising from using these estimates. There are the obvious privacy issues with this new practice: these estimates don’t require our consent, and we don’t get a right to review or approve them. Also, these estimates aren’t necessarily precise. Experian says that more than 85% of the incomes it estimates at about $35,000 will indeed be below $50,000. A representative for TransUnion said it isn’t uncommon for estimates to be off by $15,000 or $20,000. The bureaus say that their contracts with card issuers and lenders prohibit customers from being turned down solely based on the income estimates due to this the lack of precision. Typically, the lenders will request additional information, such as tax returns and pay stubs, if the estimates suggests that the potential borrower doesn’t have an income sufficient to have a new credit card or credit limit increase. Still, another concern for these estimates is other agencies using these data. For example, collection agencies have been interested in applying this data to determine the most profitable accounts to pursue.
Overall, our private information being available is a pretty scary trend. For example, Chase and Bank of America now require household income estimates. Capital One is now requesting bank account balances, investment account balances, and monthly housing costs (mortgage or rent). Fannie Mae has begun requiring mortgage lenders to verify potential borrowers income via tax returns instead of providing pay stubs and bank and brokerage account balances. Additionally, mortgage lenders are now requiring new home buyers to fill out IRS from 4506-T, which allows the IRS to release their tax filings.
I believe this regulation change is an implicit acknowledgement that the all-powerful FICO score is not adequate as the sole determinant for lending. Although this may be obvious for some, others seem to base their lives off of their credit scores. The FICO score is really just based on how someone interacts with debt and doesn’t take into account someone’s income and assets. The problem with using FICO as the sole determinant of financial solvency arises if someone chooses not to borrow money; the FICO algorithms often do not appropriately account for this kind of person. Thus, you can be a decamillionaire and have a non-existent or low FICO score. Clearly, this person would be better able to pay than most (i.e. good credit risk), yet FICO-based lending would suggest otherwise. Perhaps even more interesting though are the privacy concerns with estimated incomes now available. Now that we have opened Pandora’s box, where will it all end?
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Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.