Massaging Your Credit History

Think you'd like to save a few bucks on your next set of wheels and maybe buy some retreads? Maybe unwind a bit with a cold one at a local nightclub or shoot a few games of pool at your local billiards hall? Go ahead, but do so at your peril. You may end up ruining your credit.

A little known but widely used practice has come into the spotlight as a result of the mugging that specialty finance firm CompuCredit (Nasdaq: CCRT  ) got two weeks ago at the hands of the Federal Trade Commission (FTC). Known as behavioral modeling, it's a proactive method of mitigating risk by monitoring spending habits and making value judgments about where you spend your cash.

Under the microscope
It's a ubiquitous practice, used by MasterCard (NYSE: MA  ) , Visa (NYSE: V  ) , your bank, local credit unions … just about anyone involved in extending you credit. It isn't illegal, but also isn't familiar. When the FTC decided to go "Spitzer" on CompuCredit and publicly ruin its reputation in order to try and bring the company to heel, it highlighted the practice, alleging that the company failed to appropriately disclose that it was using behavioral scoring to make credit extension decisions. Considering that many people have been shocked by this practice, it seems that no one was disclosing that they were doing it.

Admittedly, some of this sounds pretty creepy: Who are they to judge us by where we spend our money? True, but it also makes a lot of sense. Despite the appearance that your local tire shop and Herbalife distributor are being thrown together with a bunch of seamy go-go bars, massage parlors, and pawn shops, there's some science behind it which shows that if you're running up your credit card bill at a lot of these places you become a higher risk.

Risky business
In CompuCredit's case, it makes even more sense to conduct such modeling. The company specializes in extending credit to individuals at the low end of the FICO score range. These are people who have no credit or poor credit and may have been denied credit by other card issuers because of previously not paying their bills, filing for bankruptcy protection, or other high credit risk actions. The cards are issued with a small credit line and oftentimes allow the consumer to rebuild his credit score.

If that person is using the card at such establishments, it seems pretty certain they haven't quite learned the appropriate use of credit or that their risks may be rising again. Divorces, for example, are a credit-ruining event by themselves, and someone paying for counseling with a credit card is revealing a relationship that's on the rocks. Running up a card during such stressful times and leaving the other party with a high debt bill is not uncommon.

Similarly, regularly using credit to pay for your beer at the corner tavern or even your morning coffee at the local Starbucks may indicate that you don't have the cash to pay for even basic purchases. That could be a sign of financial trouble.

Foolish financial fitness
While most people think of their FICO score as the one score used to judge creditworthiness, there are hundreds if not thousands employed by lenders to determine whether or not to extend, reduce, or renew a credit line. Information management company Fiserv (Nasdaq: FISV  ) markets a complete package of behavioral modeling and customer monitoring. 

Although Motley Fool Stock Advisor recommendation CompuCredit has been put in the crosshairs of the regulators, you should use the spotlight cast on the practice to review your own spending habits if not to improve your creditworthiness, then to bring a sense of order and control to your financial life.

MasterCard, Visa, and American Express (NYSE: AXP  ) are keeping tabs on how you pay your bills, whether you pay on time, and whether you're overextended. The least you can do is keep a close eye yourself to make sure that regardless of what the credit card companies think, your financial health is as fit as can be.

Starbucks and American Express Co. are Motley Fool Inside Value recommendations. Starbucks and CompuCredit are Motley Fool Stock Advisor picks. The Fool owns shares of Starbucks. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey owns shares of CompuCredit, but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.


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  • Report this Comment On June 27, 2008, at 1:07 PM, jeskydive wrote:

    Just pay you monthly bill in full every month and you will not have this worry. Do NOT charge more than you can pay!!

  • Report this Comment On June 27, 2008, at 3:23 PM, markwdixon wrote:

    "Known as behavioral modeling, it's a proactive method of mitigating risk by monitoring spending habits and making value judgments about where you spend your cash." This was an interesting article, but I find it hard to believe they are making "value judgments" about the expenses. That would be no better than red-lining and they would be ripe for lawsuits. More likely the behavioral modeling is statistical and the decisions are empirically correlated with higher risk. If that is the case, it is nice as a consumer to know they are doing it; but it makes perfect sense that they would use the information available to them to better mitigate risk.

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