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Can your credit score be too high?

One issuer is refusing cards to 'unprofitable' good credit customers

By Karen Kroll

Can having a high credit score ever prompt a lender to decline your application for a credit card or loan? While this sounds improbable, on rare occasions it just might be the case.

This isn't to suggest that you purposely pay your bills late, exceed your credit limit or do anything else to intentionally damage your credit score. In fact, the benefits of having a high credit score by far outweigh the few instances in which companies target consumers with weaker credit, financial experts say.

Can your credit score be too high?Deny cards to good credit customers?
Case in point: Gander Mountain Company, a retailer of hunting and camping gear, filed a lawsuit against World Financial Network Bank -- its credit card provider -- in June 2010.

According to the suit, World Financial announced that same month that it would automatically deny co-branded credit cards, or those with both the Gander Mountain and MasterCard logo, to Gander Mountain customers whose FICO scores topped 800. In explaining its actions, World Financial said that it was not earning a profit on these account holders. Neither Alliance Data Systems, the parent company of World Financial, nor Gander Mountain, would comment on the lawsuit.

Credit card issuers such as World Financial generate revenue through three primary channels, says Alicia Puente Cackley, director of financial markets and community investment with the Government Accounting Office (GAO). These are the interest payments on accounts that carry balances, the penalties assessed when account holders fail to pay their bills on time and interchange fees. Interchange fees come into play every time a cardholder makes a purchase with a card. The fees are paid by merchants and tend to run between about 1 percent and 3 percent of the purchase amounts. 

Just how much revenue each of these fees generates will vary by the issuing bank, and typically isn't made public, Cackley says. However, a 2006 GAO report, "Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Consumers," estimated that interest charges accounted for about 70 percent of issuers' credit card revenues, with penalty fees and interchange charges making up the remaining revenue.

Credit card companies are almost always profitable because the fees they charge customers more than make up for the rewards programs.

-- Mike Simkovic
Seton Hall Law School

Good credit cardholders not profitable?
That means that cardholders who pay on time and fail to rack up late fees and penalties may not be as profitable as customers who are less diligent about managing their credit. "If you pay your bill on time, the card issuers do lose a little bit there," says Robert Lawless, a law professor at the University of Illinois. Essentially, the card companies are making a small, short-term loan to these customers each time they use their cards. Considering that they may have millions of cardholders, the amounts add up.

As Lawless adds, however, the card companies still make money from good customers through interchange fees. What's more, customers with higher credit scores tend to be wealthier and make more purchases, so the interchange fees they generate will be higher.

Even so, cardholders with lower credit scores tend to be more profitable for the card companies, says Mike Simkovic, associate professor of law at Seton Hall Law School. "These people are more likely to carry balances and incur fees." Given that some of these customers may be paying 30 percent interest, along with penalties and fees, they can end up owing twice their initial balances in just a few years, Simkovic adds.

Perhaps it's not surprising, then, that "there's evidence to suggest that the card companies have not encouraged people who pay on time," Lawless notes. For instance, a 2009 study, "Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles," showed that participants with mean credit scores of 673 had an average of 2.63 credit cards with balances, compared with an average of 2.14 cards with balances for those with mean credit scores of 730. Typically, however, they've done so in ways that are more subtle than what World Financial appears to be doing, he adds. Rather than turn down potential customers with high credit scores, card companies simply won't pursue them.

There's evidence to suggest that the card companies have not encouraged people who pay on time.

-- Robert Lawless
University of Illinois

Even so, that doesn't mean consumers with lower credit scores come out ahead.

For starters, individuals who are turned down by New World (or any other card issuer) because their credit score is high still will be able to get credit elsewhere, says Ethan Ewing, president of Bills.com. When it comes to gaining access to other types of loans, such as mortgages, consumers with high credit scores have an easier time and generally pay lower interest rates.

In addition, any benefit consumers with shakier credit might gain by having access to a particular rewards card is vastly outweighed by the higher costs of most of these cards, Simkovic notes. "Credit card companies are almost always profitable because the fees they charge customers more than make up for the rewards programs."

While it's too early to predict the outcome of the lawsuit, the fact that one company appears to be pursuing consumers with lower credit scores doesn't diminish the value of having a solid credit history. "There is never a scenario in which a consumer should look to have a lower credit score," Ewing says. "No way."

See related: Taking on more credit won't hurt a credit score, The FICO 5: The components that make up a FICO credit score, How fast does your credit score recover from your goofs?

Published: July 21, 2010


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