Most borrowers know a late payment or high outstanding balance can hurt their credit. But what about frequenting a massage parlor, retreading a tire or visiting a marriage counselor? Such activities count, too, according to a suit filed June 10 by the Federal Trade Commission in Atlanta federal court against card issuer CompuCredit.
Lenders, insurers, and other financial firms use credit scoring systems to make a host of decisions about consumers, including the interest rate on their mortgages, the limits on their credit cards and the monthly premiums for their auto coverage. Some rely heavily on FICO, a three-digit score developed by Minneapolis-based financial firm Fair Isaac, while others use proprietary models developed by statisticians. But companies don't disclose what's baked into their formulas, leaving many borrowers to wonder what factors determine their financial fate.
The FTC suit against Atlanta's CompuCredit for allegedly "deceptive" marketing practices offers a rare look inside the opaque business of credit scoring. It reveals mechanisms that consumer advocates and politicians have long suspected exist -- in which purchasing behavior, not just payment history, matters.
Punished for purchasesThe allegations, in part, focus on CompuCredit's Aspire Visa, a subprime credit card for risky borrowers. The FTC claims that CompuCredit didn't properly disclose that it monitored spending and cut credit lines if consumers used their cards at certain places. Among them: tire and retreading shops, massage parlors, bars, billiard halls and marriage counseling offices.
"The company touted that cardholders could use their credit cards anywhere," says J. Reilly Dolan, assistant director for financial practices at the FTC. "What they didn't say was that you could be punished for specific kinds of purchases."The Federal Deposit Insurance Corp. is also seeking $200 million in penalties from CompuCredit in the matter.
It's not the first time CompuCredit has come under scrutiny from authorities. In 2006, the credit card issuer and another financial firm agreed to fork over $11 million to consumers and reform their marketing and billing procedures as part of a settlement with then-New York Attorney General Eliot Spitzer, who had launched a probe in 2005 after receiving various consumer complaints.
CompuCredit maintains that the FTC's lawsuit is without merit, and defends its practices. "Every time a consumer accesses their credit, a new decision to extend a loan is being made," says Rohit H. Kirpalani, CompuCredit's general counsel. "These scoring models are commonplace across the industry."With competition increasing, databases improving and technology advancing, companies can include more factors than ever in their models. And industry experts say financial firms increasingly are looking at consumer behavior, as CompuCredit did.
The worry is that companies may tweak the credit scoring systems in unfair or biased ways, weeding out or limiting borrowers based on race, gender or sexual orientation. (In the case of CompuCredit, regulators are taking issue with the lack of disclosure, not specifically its use of behavior-based scoring.)
"We as consumers should become aware that behavior is used to determine our creditworthiness," says consumer advocate Karen Gross, president of Southern Vermont College. "What CompuCredit portends is the (use) of information to create a more robust and potentially nefarious credit scoring system."
This story was reported and written by Jessica Silver-Greenberg for BusinessWeek.com.
Published Aug. 8, 2008