Dear Credit Card Adviser,
Is it true that to compensate for added risk in our recent economy, credit scoring models are lowering credit scores without any adverse activity on the part of the consumer (e.g., no new accounts, no new debt, no new inquiries, no reduced debt ratios, etc.)?
--Tim
Dear Tim,
No. Credit scoring models, such as the popular FICO model, haven't been recently altered to lower people's scores.
Rather, the changes made by skittish banks to existing accounts may cause some people's scores to drop. When an issuer closes an account or slashes a credit limit, the cardholder has less available credit. That sudden drop in available credit can adversely affect a big component of the FICO score -- the debt-to-credit limit, or utilization, ratio. This factor counts for 30 percent of your score. If the loss isn't offset, either by paying down balances or adding a higher credit limit, the credit score can suffer.
Some people who haven't done anything wrong have seen adverse actions taken against their accounts. Between April and October last year, about 11 percent of Americans saw the available credit on their revolving accounts decline, despite credit reports that showed no "risk triggers" -- late payments, public records or collection accounts -- according to a new study from FICO, the company that created the popular credit scoring model.
This group, according to the research, typically had "a very low balance, low credit utilization ratio, very few if any missed payments and a long credit history."
In this low-risk category, issuers adjusted inactive accounts and low-balance accounts. To banks, unused cards and high credit limits pose risk without profitability, and they may clip lines to reflect actual usage.
Surprisingly, their utilization increased only slightly as a result of reduced available credit, and their median score held steady at 770, which is an excellent FICO score. The reason for this, as a company spokeswoman explained to me last month, is that many consumers are reining in card use to compensate for less available credit.
Credit scoring models themselves do not punish scores. Trimmed credit limits and account closures, however, can inflict credit score damage. Scaling back debt and new purchases can help cushion the blow.
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