Saturday, March 18, 2006

What an X% default rate should mean to you, part 4

Note from 3/30/06: We users have gotten mixed answers to questions addressed to re: default rate horizons -- that is, we've been told 3 years, but then a 2 year horizon was confirmed as correct. Throughout this exercise, I'm assuming 1 year horizons (as the most pessimistic possible). Clearly, if 19% of HR borrowers default every year, that's very different from saying that over 3 years, only 19% of HR borrowers default.

In fact, I do believe the 2 year horizon is the correct one (it seems consistent w/the 2-year horizon delinquency rates I got from Fair Isaac, inventors of FICO scores), but it doesn't hurt to double expected risk as a rule of thumb when dealing with uncharted territory. (end of note)

Note 2 from 3/31/06: Looks like I was right -- the 2 year terms were for annualized numbers, so my worst-case-scenario, is actually the correct one.(end of note)

A comment on what might constitute default:

Excerpted from my official, credit report:

"How Lenders See You

A majority of lenders use FICO scores as one method to estimate an applicant's credit risk. People with high FICO scores are likely to repay loans and credit cards more consistently than people with low FICO scores. Although FICO scores are remarkably predictive, no one can predict with certainty whether or not an applicant will repay a credit account.

As a group, the consumers in your score range, 750-799, have a delinquency rate of 2%, as illustrated in the graph. This means that for every 100 borrowers in this range, approximately 2 will default on a loan, file for bankruptcy, or fall 90 days past due on at least one credit account in the next two years

Most lenders would consider consumers in this score range as extremely low risk.

Obviously, the term mentioned above is delinquency, not default, but this seems suggestive -- I had been wondering whether a single 30 day late (eg, someone forgets a bill) would be included in experian default rates.

Evidence in favor:
1.Theory:This score range on myfico is the 2nd highest bracket, or the equivalent of A range for Experian, perhaps.
2.Evidence:If A range defaults for Prosper are 0.90% per year (vs 2 years above for myfico), a rough approximation of defaults (by doubling) for A rate borrowers for 2 years would be ~=.90x2=1.80% ~=2% for the myfico defaults over 2 years.

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