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Calculating Ability to Pay

Interest rates are at all-time lows in many global economies. This makes it more attractive for consumers to take out additional loans, with money being very, very cheap. However, this may create a situation of adverse selection, with many banks reluctant to lend to higher-risk individuals who need the credit—what my fellow blogger Daniel Melo calls the profitability paradox.

In addition to internal risk policies and income-based measures, lenders traditionally assess a customer’s ability to pay by using either application scores for new customers or behavior scores for existing customers. The problem is that two customers with similar risk scores may each handle a new loan very differently based on their credit profiles. Someone with mild delinquency and low utilization may receive the same score as someone else with no delinquency but high utilization; how each would handle new debt could vary.

Income estimators and income-based measures, like debt-to-income ratios, can augment lender strategies, however even these are limited. It's quite tricky to adjust for key factors like cost of living. Not to mention income is often self-reported, difficult to verify and subject to manipulation. Even honest consumers are often unclear how to calculate this accurately: Is the lender looking for income as gross or net? Do I account for bonuses or spousal support?

FICO has been working with clients to solve the credit capacity puzzle, using our patented analytic technology that more accurately measures a consumer's ability to take on new credit. The technology almost opens a third eye on risk prediction, allowing lenders to extend loans more safely and responsibly to those most capable of repaying them. Our credit capacity analytics can be leveraged by countries with mature bureau data; where there is lack of bureau data, sometimes internal behavior data can be used.

Lenders today are challenged with economic uncertainty and severe competition to attract and retain best customers. In this environment, yesterday's risk assessment tools may no longer be enough.

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Jon Haver

Since I am on the consumer side of loans (student, mortgage) etc I always wonder what metrics are used by brokers to determine my ability to repay.

It seems very policy based and most brokers I have worked with punch the numbers into their computer and with very little/no analysis report whether or not I qualify for the loan. What goes on in that black box is a mystery to me and most likely the broker I was working with.

Thanks for shedding some light on the analysis that goes on behind the scenes.


Interesting read, thanks for sharing some insights into the consumer lending process. Always great to see a company like yours using technology to make advances in an industry.

Carmen Sanchez

Thanks for sharing this post. I have been struggling with bankruptcy in Edmonton and the all time low interest rates made it possible for me to get out of my immense debt. Thanks again.

John Haver

Very interesting....there is so much great information out there I really hope students and those who want to purchase homes take a minute and do some research before applying for loans so they can see how the process works instead of going into it blindly.

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