Another scoring system, bankruptcy, helps determine credit-worthiness

A couple of days after applying for a $15,000 home equity line of credit in early July, Brentwood resident Vince Laboon got a letter in the mail with a mysterious entry: his “bankruptcy score.”

“I was nervous about what that meant,” said Laboon, 36, who sought the money from Citizens Bank for home improvements. “The letter didn’t really tell me anything. It was odd.”

But not unusual. Like the more-familiar credit score, a bankruptcy score is another means for lenders and credit-card issuers to gauge an applicant’s credit-worthiness, experts say. The score is an attempt to determine how probable it is for a potential borrower to declare bankruptcy.

Citizens did approve a credit line for Laboon, who said he got high marks on both his bankruptcy score and his credit score — the latter sometimes called a “Fico score.”

A bankruptcy score “is one of several factors we use to evaluate a customer’s credit-worthiness,” said Citizens spokeswoman Sylvia Bronner. Privacy rules prohibited her from discussing particular borrowers.

Citizens is hardly different from most big banks. In addition to credit scores, they use bankruptcy scores to help decide whether to make mortgage, auto, and other loans and to determine whether to issue credit cards.

A bankruptcy score is “a tool for lenders to identify customers who statistically have a higher likelihood of bankruptcy,” said Anthony Sprauve, spokesman for Fair Isaac Corp., Minneapolis. Often going by its acronym,”Fico,” the company is the leading third-party provider of credit, bankruptcy and other scoring systems.

Fico’s scores are used by more than 90 of the nation’s 100 largest banks, the top 25 credit-card issuers and the top 25 auto lenders, Sprauve said. He was not allowed to identify them by name.

Fair Isaac creates a bankruptcy score, he said, by applying mathematical formulas to masses of credit-related information collected by credit bureaus from lenders.

Like a credit score, a bankruptcy score evaluates a loan applicant’s payment and delinquency history, amounts owed, number and type of credit relationships, and the like, Sprauve said. The bankruptcy score, however, puts more weight on the person’s current debt load.

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“One thing that’s different is (examining) how much debt you acquired in a short time frame,” said Scott Dressler, associate professor of economics at Villanova School of Business, Radnor. “That’s because one thing people do before going under water is pile on a lot of debt before they declare bankruptcy.”

While normally shrouded from consumers’ view, bankruptcy scores have been around for about 20 years, said finance experts.

“There’s a lot of mystery behind these (bankruptcy score) numbers. Different institutions use different systems,” said Dressler. “But they are not standardized, which means their use is rather arbitrary.”

Bankruptcy-score scales may run from 1 to 800 or from 50 to 950 or from 1 to 300, depending on who is producing them, he said. But a common element is that the higher the score, the more credit-worthy the applicant.

“A lot of financial institutions use a dual score strategy because they are assessing all facets of risk,” said Demitra Wilson, a spokeswoman for Equifax Inc., a credit bureau.

PNC Bank, by far this region’s largest bank, uses its own system of “proprietary mathematical rules to assess risks, including bankruptcy,” associated with all types of consumer lending, said spokeswoman Amy Vargo.

Dollar Bank, on the other hand, does not use bankruptcy scores “for any of our lending decisions,” said Joseph Smith, senior vice president.

Nor does First National Bank of Pennsylvania use bankruptcy scores, said Barry Robinson, executive vice president of consumer banking.

“Bankruptcy scores are more often used by larger lenders, whose credit decisions are more automated and less judgmental in nature, and by credit card companies who deal with unsecured credit on a larger scale,” Robinson said.

“Acquiring bankruptcy scores adds incremental cost, and the value gained is not always worth the extra expense,” he said.

How well bankruptcy scores predict a person’s filing one is not clear.

“Any of these scoring systems is kind of a game of playing the odds,” said Dave Cashman, senior business consultant at Experian, Costa Mesa, Calif., one of the nation’s three credit bureaus.

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“It’s not really about predicting that customer ‘A’ will go bankrupt. It’s more that out of 1,000 customers who look (on paper) like customer ‘A,’ maybe say, 50 will go bankrupt,” said Cashman.

“The application of these scores precludes some people from getting credit, but it also lowers the cost of credit for everyone because it reduces the amount of bad debt for the lenders,” Cashman said.

While excessive debt often pushes people into bankruptcy, other less foreseeable factors do, too. According to the Institute for Financial Literacy, injuries and illnesses are one of the leading causes of person bankruptcy.

“With things like credit card spending, you can predict the likelihood of someone filing for bankruptcy,” said Villanova’s Dressler. “But for things like medical bills, they’ll never be able to predict things like that.”