Survival Analysis Methods for Personal Loan Data

Jul 29th, 2002 by Tony in * papers

The Mar/Apr issue of Operations Research has an interesting article on credit scoring models. Traditionally credit scoring has been about minimising the risk of making loans to customers likely to default on the loan. But over the last few years people have started to realise that this probably isn’t enough. In fact, even a customer who has a high likelihoold of default could actually be profitable as long as the default comes far enough in the future for the interest payments made before that point to exceed the losses caused by the default.

The real issue for most lenders now is the risk of the customer paying off their loan too early for the lender to make any money. This often happens with the borrower switching to a competitor – a practice that has become particularly rife in the Credit Card industry – more and more customers are moving their balance to a new card with a super-low introductory rate (often 0%), and then moving to a competitor when the introduction period runs out. Similar things are also happening more and more in the mortage industry, and increasingly so in “normal” personal loans.

Traditional tables of “likelihood of default” provide average figures based on a variety of characteristics of the borrower tabulated against the purpose of the loan, that can be used to decide how risky the loan would be. Unsurprisingly, the likelihood of switching in each of these cases is very different from the likelihood of defaulting.

I’m curious now how long it’s going to be before information like this starts to be taken into account on people’s credit reports, or asked for on applications. Most credit card applications ask how many other credit cards you have, but I don’t think I’ve seen any yet that ask how many you have had…

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