In math we trust: the analytical secrets of credit card companies

Introduction

I have a heightened sensibility when it comes to recognizing the use of data mining and analytics.  Having studied computer science in college, I am fairly knowledgeable of those disciplines. So it was no coincidence that I was able to draw attention to the ill-conceived data mining practices of American Express.  Ultimately, my public relations salvo against American Express was not about me being a victim; instead, it was about the credit card company understanding the need to change its algorithm.

I am not sure whether American Express made any adjustments as a result of my efforts and the ensuing public outrage—it said it did—but I do believe that all credit card companies learned a sobering lesson: Mathematical models built on dubious assumptions can and do backfire.  In fact, one of the reasons I think my story was so popular—and continues to be today—is that the current economic crisis occurred, in large part, due to our increased reliance on and faith in esoteric and erroneous mathematical models.

During the height of my notoriety, I received hundreds of e-mails from concerned consumers, asking me and giving me insider information about how these models and algorithms work.  I responded to each inquiry and often posted these responses in detail on my blog.  However, I have never delved into the mathematical concepts of data analysis with an emphasis on how a credit card company might use them. Well, not until now. 

My desire to explain some basic methodologies and models on this blog comes from the realization that we live in an increasingly data-driven society.  From internet searches to phone records, from credit card purchases to tax returns, companies have access to huge data sets which enable them to, in many cases, know us better than we know ourselves. The access to and interpretation of such data empowers companies beyond belief. This tremendous power should go neither unchecked nor overlooked, especially by the very consumers who are often the subjects of its manipulation. 

The next few posts will introduce you to the world of analytics.  They will give you confidence to challenge its applications and assumptions.  But most importantly, they will help you gain more control over your destiny, which is increasingly determined by the use of mathematical formulas.

5 ways your bank spies on you

Today I received an e-mail message from a fan of this blog, informing me that I was mentioned in an MSN Money article.  I had no idea.  (It didn’t show up in my Google alerts.)  Naturally, I searched and found the mention. The article, entitled “5 ways your bank spies on you”, is a great read, so check it out.

How credit cards with no spending limits can hurt your credit score

A great article recently published by The New York Times investigates how credit cards with no limits can hurt your credit score.  I highly recommend that you read it.

Also, be sure to read this article: “There is no such thing as a credit card with no limit”. It will help you better understand how some of these cards actually work.

Think twice before you ‘Like’: Social media are credit card companies’ newest weapon

Better risk management: That was the biggest and hardest lesson learned by credit card companies during the credit crunch, which started in fall of 2008.  Ever since that frightening period—some call it 'The Great Recession’—consumers and businesses alike have experienced tighter risk management through closed accounts, reduced credit lines, higher interest rates, and more stringent guidelines for credit applicants. 

In an unprecedented effort to minimize their risk, credit card companies and banks have sought every possible resource at their disposal to capture and to store more information about customers—and that includes using social media. While many consumers understand that companies have access to their transaction histories and credit reports, most overlook the tremendous metadata available via social media companies like Facebook.  With the help of such new media, credit card companies have almost a 360 degree look at their customers. 

Capital One the latest to report business debt to personal credit bureaus

Some people dread going to the dentist.  Others dread speaking in public. I dread getting my credit report. 

This fear exists not because I have bad credit, but because I know that as a business owner, I am vulnerable to the reprisals of credit card companies which, in response to the passage of the Credit CARD Act, have begun to take out their frustrations on small businesses.  Because credit cards issued to businesses are not covered under the new act, business owners are sitting ducks.

I checked my credit report a few days ago.  Everything was prefect except one thing:  One of my business creditors, Capital One, began reporting my business credit to all three personal credit bureaus in October 2009.  In other words, no longer are my personal debt and business debt separate.  My worst nightmare came true.

Garnishments on the rise as debtors struggle to pay debts

When in dire financial straits, the easiest thing to do is to disconnect the phone line, avoid opening the mail, or simply disappear altogether.  While it is the easiest thing to do, it is not the smartest thing to do, as more and more people are finding out the hard way. 

As reported recently by The New York Times, garnishments are on the rise.  Garnishment is a process by which creditors can secure a court order to seize part of the debtor’s paycheck or the funds in a bank account. The article states that, “… pay seizures are rising fast in some areas — up 121 percent in the Phoenix area since 2005, and 55 percent in the Atlanta area since 2004. In Cleveland, garnishments jumped 30 percent between 2008 and 2009 alone.”

One of the main reasons for the increase is debtors’ fear and unwillingness to communicate with their creditors, a tactic that will get a debtor on the fast track to garnishment. Avoiding creditors is the worst move you can make.

In short, if you are way behind on your bills or owe a major debt, be sure to make an attempt to resolve the issue quickly.  For example, when a friend of mine fell into financial hard times, he contacted his mortgage bank to request more favorable terms. As a result, his bank lowered his payment and forgave some of his loan.  Being proactive, you will come out better in the end, and you will have, at least, some peace of mind that a creditor is not waiting to raid your bank account.

 [ Read The New York Times article. ]

Another reason to pay your credit card balance in full every month: returns

There are several reasons you should pay your balance in full every month.  I recently discovered yet another. 

A few weeks ago, I purchased a converter box for my analog TV. The experience was difficult and embarrassing, considering that few stores still carry converter boxes and that I’m probably the only person in the world who doesn’t have cable. (I haven’t had cable in over 10 years.) 

After installing the box and antenna, I realized that I couldn’t get ABC and that some of the other channels didn’t come in strong.  What a waste of almost $80!  I returned the box and accessories a few days later, but I wondered if I would pay any finance charges to my credit card’s bank during the time I had the products.

Here’s the answer. Let’s assume that my $80 transaction is the only purchase on my credit card, and that the transaction occurred on the first day of my 30-day billing cycle.  If I had waited too long to return the items—longer than my billing cycle—and hadn’t paid my balance in full, I would have lost money.  In other words, I would have paid finance charges on my daily balance of $80.  If my Annual Percentage Rate (APR) was 15.9%, and thus my Periodic Rate was 0.04356% (APR divided by 365 days), I would have ended up paying about $1.05.

So, in short, even if you a return an item and get a full refund, you can still end up paying finance charges on the money you borrowed from the bank. Just make sure you return items within the billing cycle you purchased them.

Related article(s): [ How paying your bill early saves money ]

How to change your name with the credit bureaus after marriage

Finding out how to change your name after marriage can be a difficult and tedious task, especially when it comes to making sure that the three major credit bureaus, Equifax, Experian, and TransUnion, have current information.  If you have to change your name, my wife’s recent experience will help you avoid increased agony. 

The most important rule to staying out of debt

 

Few financial experts, if any, will include the following rule in their recommendations for staying out of debt: Make sure you have and keep health insurance. Not only do I recommend it, but I think it is most important.   

This realization came to mind yesterday as I rode in the ambulance with my younger sister, a victim of a hit and run here in Atlanta. As we headed to the hospital, the EMT asked for my sister’s health insurance information.  She gave it to him while I praised in relief, “Isn’t it a blessing to be able to say that!” The EMT agreed enthusiastically, “Yes!” As he made the final stroke on his digital tablet, he mentioned that recently he canceled his health insurance to save some money. Struck silent by the tremendous irony of an EMT canceling his health insurance, I listened intently.   He continued, saying that he luckily reinstated it two months before he came down with pneumonia.  Yes. He was lucky. My sister was lucky too: Despite the car being totaled, she only received a few minor bruises and was able to go home early in the morning. She slept well, knowing that her bills were covered.

Unfortunately, the great majority of people in my sister’s situation are not as lucky.  Medical bills are the leading cause of bankruptcy and high credit card debt in the United States.  According to a recent CNN article, “60 percent of people who go bankrupt are actually capsized by medical bills”. I must admit that I thought the majority of bankruptcies were caused by shopaholics who enjoy this country’s favorite past time: conspicuous consumption. That all changed when I started my blog a year ago. From day one, I received heartbreaking e-mails from everyday people who fell seriously ill and because of lack of health insurance had maxed out their credit cards. 

Here is a depressing excerpt from “Jessica’s” e-mail sent to me a year ago:

How a loan modification can damage your credit

An article released in The New York Times on Jan. 1 reports that economists and housing industry experts believe that President Obama’s plan to fight the foreclosure crisis is not working.  In fact, many believe that the President’s $75 billion plan, which compels banks to lower monthly mortgage payments, has backfired and prolonged the recovery process. 

The article mentions briefly an important and little-known consequence of the program: the fact that some borrowers who accept a loan modification receive adverse reporting on their credit reports.  Certain banks, such as Bank of America, have reported to credit rating agencies that homeowners are making only partial payments.  This occurred despite some borrowers being told by their mortgage companies that their credit would not be damaged. 

Create your own data mining strategy

Whenever creditors call you—for whatever reason, good or bad—they are keeping record of almost everything.  They record the date and time, what you say, what they say, your tone and temperament, etc.  Likewise, they know when you log onto their web sites to make a payment or to check a balance.  In addition to information pulled from your credit report or account history, companies have a comprehensive dossier on you.  You should do the same.

Credit limits reduced—again and again!

Normally, consumers wouldn’t equate their credit card company with an electric cattle prod, but that’s just the type of imagery that comes to mind for many disgusted credit cardholders who are feeling the shock of multiple credit line reductions.   

In December of last year, many readers who saw my story in the media informed me that their credit card company lowered their credit limit multiple times.  One woman, for example, complained that every time she paid down her balance, the credit card company would lower her credit limit.  To add insult to injury, sometimes the company would lower the limit below her outstanding balance, causing over-the-limit fees!  The majority of the complaints I received were about American Express. 

Not until recently have I seen this practice of “chasing down the balance” reported.  It’s about time.  In an article published today in The Wall Street Journal, Gordon Deal offers some good advice on how to deal with this growing and cruel tactic used by some companies. 

[ Read the article in The Wall Street Journal. ]

How paying your bill early saves money

For credit card customers who carry a balance month-to-month—something I strongly discourage—there is a simple way to reduce finance charges: make payments earlier than the due date.

Here is how it works mathematically.  To calculate finance charges, most credit card companies use your Average Daily Balance (ADB), which is the total of the balance at the end of each day during a period divided by the number of days in the period.   For example, CapitalOne calculates its finance charges using your Average Daily Balance.  Here is what CapitalOne’s fine print says:

“Finance charge is calculated by multiplying the daily balance of each segment of your account (e.g., cash advance, purchase, special transfer, and special purchase) by the corresponding daily periodic rate(s) that has been previously disclosed to you.  At the end of each day during the billing period, we apply the daily periodic rate for each segment of your account to the daily balance of each segment.  Then at the end of the billing period, we add up the results of these daily calculations to arrive at your periodic finance charge for your account.”

There is more fine print and special cases, but I don’t want to put you to sleep.  In a nutshell, the higher your daily balance, the more you pay in finance charges.  Thus, it pays to reduce your balance whenever you can. 

For instance, let’s say your incoming balance for a billing cycle in April is $1,000.  For the first five days of the billing cycle, you make $400 worth of purchases ($250 on Apr. 2 and $150 on Apr. 3). Also, your Annual Percentage Rate (APR) is 15.9%, and therefore your Periodic Rate is 0.04356% (APR divided by 365 days).  Below is what your Average Daily Balance and finance charges computation would look like. 

DATE	PURCHASES	PAYMENTS	BALANCE	FINANCE CHARGE
Apr 01			$1,000	$0.44
Apr 02	$250		$1,250	$0.54
Apr 03	$150		$1,400	$0.61
Apr 04		$800	$600	$0.26
Apr 05			$600	$0.26

Total Daily Balances	$4,850
Number of Days	5
Average Daily Balance	$970
Total Finance Charges	$2.11

Now, let’s consider the entire 30-day billing cycle.  If you didn’t make any more transactions after Apr. 5 and waited to make your $800 payment on the due date May 1st, your average daily balance would be about $720 higher and would cost you about $10 more in finance charges.  Thus, your finance charges would be much more.  If you tend to make especially large transactions using a credit card, paying early will help you save a significant amount of money. One exception is if you pay within the grace period, a period of about 25 days during which no finance charges are applied.  

In short, it pays to pay early.  In fact, you can even devise a plan for paying a bill twice a month instead of once.  I often do just that, or after a large transaction, I’ll make a payment that same day for the amount I just charged.  And for those of you who are thinking about paying more than you owe: no, the companies will not pay you extra. 

Customers not totally safe after seven years

If you think your credit is safe because you have not made any financial mistakes during the last seven years (the maximum amount of time that derogatory information can legally stay on your credit report), I have bad news for you.  In some cases, your mistakes from years ago, perhaps as far back as 20 years, can return to haunt you, especially now when credit card companies are looking for any reason to get rid of you. 

Customer threatens Chase, gets low interest rate restored

Some Chase customers are learning the hard way: just because your account is closed does not mean you are immune to sudden interest rate hikes. 

In Nov. 2007, Chris from Missouri closed his Chase credit card account.  Since then, he has made progress in paying off the balance owed but has just under $2,400 left to pay.  The interest rate on his account has remained the same.

However, in Jan., Chris received correspondence from Chase informing him of an interest rate increase from 8.99% to 13.24%.  As he explained in an e-mail, “It was the standard tri-fold with the ‘Important information regarding your account’. It’s almost like they bumped it [the interest rate] up a little to see if I would catch it.”  Or perhaps Chase was hoping that if Chris noticed, he would think the increase was nominal and accept it.

FICO score optimized for the last two years of credit history

One of the most common pieces of advice about improving a credit score is: pay bills on time, lower outstanding balances, and wait.  Wait for what?  The rather vague reference to time reminds me of the words a young man might hear from his mother after a bad breakup: “Son, time heals all wounds.”  Such answers are not comforting at all for the immediate pain.  What’s the quick fix?   

There is no quick fix. However, while the advice to wait is true, much better advice would inform consumers of just how long they should wait to see a significant improvement in their credit score. 

Companies cancel cards of responsible customers

Why do bad things happen to good people? This question has been one of the most difficult questions in theology throughout history.  I say this not to draw parallels between credit card companies and God, but without the proper regulation in place, capricious companies will continue to operate in omnipotent ways.  Meanwhile, fatalistic customers can only submit to the wayward will of profit-seeking companies.  I suppose you could call it the credit crucifixion instead of the credit crunch. 

The days of companies rewarding responsibility are over.  In their latest efforts to minimize risk and maximize customer pain, credit card companies are canceling accounts of those who don’t use their cards often or at all. Some of the targets are “transactors” and “freeloaders”, those who pay their balances in full every month.  Others are customers who prefer to have credit cards for emergencies only, and therefore hoard cards with zero balances in the bottom of a drawer somewhere.  They make companies hardly any money and all that available credit is dead weight

How creditors can estimate how much cash you have

One of the first steps you can take in the business world to assess the health of a public company is to peruse its prospectus, a document that details important facts about a company including financial statements.  By reading a company’s prospectus, you can determine how much cash it has and how well it manages cash flow.  Investors know that successful management of cash flow is often an indication of success.  On the other hand, poor management of cash flow, perhaps with a large amount of debt as well, often is an indication of failure.  

Learn to live on one income

Amid the barrage of bad news we hear everyday about the out-of-control economy, there is a powerful lesson, one that is difficult to hear and even more difficult to live by.  In fact, it is a lesson that skittish banks are learning the hard way as they scramble to find ways to solvency –just like many of us.  The lesson is only two important words: minimize risk. 

However, unlike the banks, we should not wait until dire circumstances threaten our livelihood to minimize risk; it must be an ongoing exercise of caution. Unlike the banks, we aren’t minimizing risk to manage profits; instead, we are minimizing risk to ensure a stable home for our children, to retire at a reasonable age, etc.  The reality is many of us don’t have a TARP, a trust fund, mom and dad’s benevolence, an emergency fund with hundreds of thousands of dollars, or an unused credit card, especially now. Our personal finances are far more urgent.  

Avoid credit reductions and increase your credit score by being a "freeloader"

When Kevin asked me to write a guest post, I wanted to write about things you can do to counteract the new credit card industry practice focused on higher interest rates and lowering credit card limits.  

One thing you can do is to become a "freeloader".  This is credit card companies call someone who uses their cards but never carries a balance. Now, some folks are out there saying that this behavior can hurt your credit score.  Non-sense.  I have not carried a balance in as long as I can remember and my score has been above 760 for over 4 years and probably longer.  The statement “paying off the entire balance in full each month, the credit bureaus don’t see you as really borrowing any money at all” is flawed. Paying off balances before they are due DOES show something about your credit behavior and IS a good prediction of risk.

Beware: These stores could harm your credit! (Part II)

American Express is tight-lipped about the following statement I received in a letter notifying me of a credit limit reduction: “Other customers who have used their card at establishments where you recently shopped have a poor repayment history with American Express.”  The implications of such a statement are alarming. 

On Jan. 21, the executive’s office dodged all direct questions I asked.  Some of these questions included: What does the statement mean? What are the “establishments”?  Every question was deliberately dodged during the thirty minutes I spoke with the representative.  Her voice quivered with suspicion and self-incrimination.  After the cordial conversation, I gave up. 

Since American Express won’t tell me which establishments are bad, perhaps you can help me.  Below are all of the businesses I have patronized during the time that I have had the card from Dec. 2006 to Jan. 2009.  Which do you think are the bad “establishments”?

Bait and switch: More rewards could mean less credit

I’m certain you’ve seen it at least once: the movie scene in which a jittery bank robber demands that “nobody move”.  Or he may say, “Don’t do anything funny!”  I’ve also heard, “No sudden movements!” 

That scene is what comes to mind every time I get an e-mail from one of my credit card companies encouraging me to buy this and that, to take advantage of this offer and of that offer.  I’ve noticed that the e-mails have become more frequent and more aggressive.  It’s almost as if there is an inverse relationship between a declining economy and how much creditors want you to spend. 

Mortgage default, deduct over 200 points

It’s no coincidence that the word “mortgage” sounds a lot like mortician, morbid, morgue, and mortified.  In fact, mortgage literally means "dead pledge".  Put another way, it is a deal that dies either when the debt is paid or when payment fails.  However, these days it seems to mean something more ominous: a monthly visit from the Grim Reaper. 

Because more and more people cannot fight off the Prince of Death in this dying economy of declining home prices and major layoffs, walking away from a mortgage is becoming more common.  Reasons range from the house being underwater to not being able to make the payments. 

Rule: Report increased income with creditors

If your income increases during the time that you have a credit card or a line of credit, definitely update that information.  Customers often fail to do this and therefore, are being reassessed based on outdated information.  Credit card companies review accounts on a periodic basis for risk assessment, the results of which could mean an increase or a decrease of credit available.  Without reporting increased income, you may be shooting yourself in the foot.  Your increased ability to pay for debt will have a positive effect on your access to credit.  In the same way that a larger income permits a borrower to buy a bigger home, a larger income permits a borrower to have more access to credit.  Likewise, if your business revenues increase, update that information.  Not doing so could cripple the growth of your business should the opportunity come suddenly.

Four out of five credit reports have errors

Yes. That’s right.  Chances are you have an error on your credit report.  Hundreds of millions of credit reports have errors such as incorrect or incomplete personal information, accounts that don’t belong, accounts with inaccurate history, etc.  While some of these errors may seem like trifles, they can negatively affect how a creditor views you.

I check my reports often and they still have errors after many attempts to get them fixed. For example, I’ve tried to correct an incorrect address for about three years now, all to no avail.  Apparently, I used to live in Houston, Texas, y’all.  Also, each one of my reports from the three main credit bureaus has different information.  The differences are small, but enough to cause concern. 

Your credit score isn't what you think it is

Credit scoring is not, by any means, an exact science. Put another way, your score can vary greatly depending on the source of evaluation.  To say that credit scoring is an exact science would be like saying that all high schools have the same grading system. Some schools use the 4.0 system. Others use the 5.0 system. Still, others use letters and restrain from using pluses and minuses.  Despite the variance, creditors can still get a good picture of your credit worthiness, but be careful in assuming that you know the score they are using.   

Of the three main credit reporting bureaus, Equifax tends to produce the lowest scores on average.  Next is TransUnion, which tends to have higher scores than Equifax.  Finally, there is Experian, which tends to have the highest scores of all.  For example, someone can have a 707 with Equifax, a 736 with TransUnion, and an 818 with Experian –and all bureaus are looking at the same exact information.  Most companies use only Equifax’s scores. 

What affects your credit score

As I continue on my goal of educating millions about practical steps consumers can take to improve their finances, I often receive questions about what actions have the most effect on a FICO score, the number creditors use to assess risk. 

The five main components of a FICO score are: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and types of credit used (10%).  As exhibited in the graph to the right, the most important components are payment history and amounts owed, but all components are important factors.   

How credit card companies track your purchases via tracking codes

While talking with my wife yesterday, she mentioned that she was going to make a purchase for something –I think for groceries or for a medical co-payment.  I cannot remember what it was for, but her intentions did prompt me to say, “Don’t use your credit card. Use cash because the type of purchase could trigger a negative reaction by your creditor.” 

She looked at me like I was crazy and said nothing. She didn’t have to; her looks said it all.  Considering my situation with American Express, I expected instant agreement, but her automatic response was an indication of how difficult it will be to get people to change their habits.  I think her silence was the guilt she felt after she realized that I was probably right. 

Need better credit? Change your address or move

A friend of mine who saw my story in the Atlanta Journal-Constitution commented that my efforts to prevent credit card redlining by changing the law are futile –at least in the short term.  She also said that I would need an army of like-minded, dedicated, upset consumers to get the attention of legislators and the federal government –as many as the 65,000 “soldiers” that it took to get the Federal Reserve to make sweeping changes. Despite her pessimistic tone and smug self-importance that turned me off, some of her points were convincing.   

She also said sarcastically that while I am running for office or chasing lobbyists, I should change my home address.  In other words, I should locate an affluent neighborhood and find a business there –say Mailboxes Etc.– that can serve as my fictitious home address.   Doing this would make me virtually immune to credit card redlining.    

Beware: These stores could harm your credit!

Credit card companies have finally gone on record saying that they grant credit based on where a person shops –and lives if you haven’t heard that too.  I already knew, but I had to find out the hard way.  

The strange thing is that the companies won’t reveal what stores or “establishments” will negatively affect your credit rating.  An American Express spokesperson says that the reason they won’t reveal the information, in part, is because their “property risk model” changes frequently.  Does that mean every day, every week, every month?  I suppose they could alert me via e-mail just like they send me special offers to patronize, for example, Wal-Mart.  I think they just don’t want to reveal that information. It wouldn’t be good business to discredit (pun intended) a business partner that brings you millions in interchange fees.