Financial fragility is “the ability to cope with emergency expenses” (pdf). Understanding how robust a customer’s financial position is a valuable way to quickly size up what’s happening with a delinquent customer. The level of financial fragility is especially useful for customers in the initial 1-29 day delinquency bucket. Why?
Think of that first delinquency bucket as the Grand Central Terminal in New York. Thousands of unknown customers streaming into the station:
What are their destinations? When a customer initially shows up in collections, they are something of a mystery. They have a balance amount and transaction history. But not much else. It turns out a single question can help you understand the route of each customer in the first stage of collections. A question about financial fragility.
Financial Fragility: Correlated with Credit Scores
Since 2009, the National Financial Capability Study has asked this question of American consumers:
How confident are you that you could come up with $2,000
if an unexpected need arose within the next month?
The $2,000 amount “is reflective of a mid-size shock, such as an unexpected health shock, a major car repair, or an unanticipated legal expense—all categories of expenditure that can be commonplace in people’s lives” (pdf). Four possible answers are shown: I’m certain I could, I could probably, I could probably not, I’m certain I could not. The results over a series of years provide a glimpse into the financial fragility of Americans.
Dr. Christopher Trepel, then the Chief Science Officer for Encore Group, reported a 2014 study of financial fragility. He modified the question about raising $2,000 to ask how the person would come up with the money. 366 people were asked how they would source $2,000, and separately their Vantage scores were pulled. The graphic below combines the two data elements. Note, prime credit = 701+ Vantage score.
You can see a pecking order of the funding sources relative to credit quality. For prime and subprime customers, the percentages selecting a particular funding source are shown. Savings were the overwhelming choice of prime credit customers, with mainstream credit a significant second choice. Meanwhile, subprime customers show a higher reliance on less stable sources, including family or friends, work longer hours, or even unable to cope.
Three years later, we asked the same question of 846 credit union customers. We had FICO scores, and used Experian’s definition of prime as 670 or greater. In the chart below, you’ll see a very similar pecking order of sources vs. credit quality.
Different customers three years apart, but the same story that Dr. Trepel found. The link between sourcing $2,000 and credit quality is clearly established. It works with customers in good standing, but what about for collections?
Raising $2,000: Correlated with Serious Delinquency
As the Grand Central of collections, the 1-29 DPD bucket suffers from this dynamic: thousands of delinquent customers streaming in with insufficient information. Minor blip? Short-term cash crunch? Long-term difficulty? The lack of information means everyone gets the same treatment. Imagine if there was a quick way to gain a deeper understanding of the delinquent customer’s situation.
Turns out, there is. Ask them how they would source $2,000 within the next month. 13,566 customers in the initial 1-29 DPD delinquency bucket completed BackOnTrack. During BackOnTrack, customers are asked how they would source $2,000 if they had to within the next month. For purposes of balancing the user experience with data collection, the choices are pared down to five.
We were able to track the payment performance of collections customers who answered this question over the next 4-11 months. The finding? A pecking order similar to what we saw with the earlier studies. The table below shows the serious delinquency (90+ DPD) unit rates by funding source.
|Current savings or retirement funds||7.7%|
|Family and friends||12.6%|
|Credit cards, home equity, loan||16.0%|
|Working longer hours||16.1%|
A simple question, asked at the outset of delinquency, provides insight into the payment risk for each customer months later. The more stable sources – savings and mainstream credit – perform better. This is similar to the choices of prime credit risk customers. The less stable sources saw higher rates of serious delinquency, which maps to the choices of subprime consumers. The source for raising $2,000 not only tracks to credit quality, it also tracks to payment behavior.
By asking this one question, creditors immediately gain perspective on the customer’s financial situation. Knowing the financial fragility of a customer allows for more effective engagement early. This is valuable for delinquency mitigation, not just fulfilling the daily cash collected goal.
Click here to learn how BackOnTrack not only reduces bad debt expense, but also provides valuable early data about a customer’s risk.