FICO scores stable despite slashed credit limits, study says
Nearly 20 million consumers had their credit lines reduced or eliminated over a six-month period in 2008 through no fault of their own, but credit scores overall were largely unaffected, according to a study released today by credit scoring giant FICO.
FICO conducts ongoing research to see how well its scores hold up under real-world conditions. As banks continued to tighten access to credit last year, FICO decided to consider how lowered credit limits and closed accounts were altering borrowers' FICO credit scores. The key finding of the study: Not much.
Although consumers who saw negative items appear on their credit reports experienced a slight drop in credit scores, borrowers overall experienced little change to their FICO scores, since lenders primarily targeted consumers with already solid credit histories for account closures and line reductions. For borrowers as a whole, the median FICO score remained unchanged over the time period considered.
That is good news for consumers worried about how changes beyond their control could impact their access to credit. "For approximately 88 percent of consumers, the movement of their scores during this period was relatively small and would have had little to no impact on credit-granting decisions," FICO says.
What about FICO?
FICO scores are snapshots of consumers' borrowing behavior condensed into to a three-digit number. Part of the score's calculation depends on the amount of credit currently in use compared to the total amount of credit the borrower has available. This ratio, known as the credit utilization ratio, therefore changes when a bank suddenly decides to trim a borrower's access to credit. Since FICO scores consider more than just a borrower's credit utilization, the movement of other factors also have an impact.
"If we could hold all other conditions constant, we would expect that a reduction in available revolving credit would either have no impact on an individual's FICO score or would cause it to decrease," FICO says in a press release. "In reality, the information on credit reports seldom stays fixed or constant. Our research shows that an individual's score may go down, go up or stay the same after the lender reduces a borrower's credit limit or closes the account."
Interactive: How FICO 08 changes
will impact you
After a number of delays, credit score creator FICO (formerly known as Fair Isaac) finally introduced its updated scoring model in late January 2009. That new credit scoring model -- known as FICO 08 -- is designed to more accurately predict consumer borrowing behavior, such as the likelihood that a borrower will be able to repay a loan.
While FICO acknowledges that credit card issuers have traditionally lowered the amount of revolving credit offered to borrowers or closed inactive credit card accounts to control risk exposure, the latest moves by banks come during a time of unusual strain for the lending industry. As losses mount, banks are actually targeting borrowers with solid credit histories. "What appears unusual in the current environment is adjustments by many lenders to the amount of credit available to customers whose credit reports do not contain recent indications of increased riskiness," FICO says.
Solid credit histories mean little change
During the period considered by the study -- April 2008 to October 2008 -- FICO found 16 percent of consumers had their credit limits reduced. The bulk of that group (11 percent) was made up of borrowers who didn't have any record of a "risk trigger" -- a late payment, account in collections or public record -- added to their credit report during those six months. That group appears to be most representative of the U.S. population at large, since FICO says approximately 80 percent of U.S. borrowers had no risk trigger added to their credit reports between April and October of last year.
One major reason credit scores didn't suffer is that card issuers snatched credit from those who had good scores to start with. Banks apparently targeted borrowers with inactive or low credit card balances, a group that was generally very low-risk, with a median FICO score of 770 and credit cards that tended to have very low balances, low credit-utilization ratios, very few (if any) missed payments and lengthy credit histories. On average, FICO says that lenders cut the total revolving credit available to borrowers with no risk-triggers by $2,200 -- a total FICO deems "a relatively small amount." FICO says that was about 5 percent of the total revolving credit available ($44,000) to this group during the six months it considered in the study.
For nearly 44 percent of the group, FICO says credit reductions amounted to $1,000 or less. As these reductions were taking place, credit utilization ratios for this segment of borrowers rose, but only slightly, from 22 percent to 26 percent. FICO says that slight increase indicates that many of these borrowers were maintaining or reducing (rather than increasing) their credit card balances. "Such credit behavior would help to minimize the impact to their FICO scores," FICO says.
Still, consumer advocates don't necessarily find the data reassuring. "I find it interesting that so many people suffered reductions in credit limits apparently for no good reason," says Linda Sherry, national priorities director for nonprofit consumer rights group Consumer Action in Washington, D.C.
Meanwhile, according to FICO's study, an interesting thing appears to have happened: Low-risk borrowers saw little movement in their FICO scores, with a median of 770 in October. FICO says those scores are due to lender updates to credit reports which "reflected good credit habits such as paying bills on time, paying down revolving debt and taking on new credit sparingly."
More widely, when credit scores did change, they didn't change by much. FICO says that the majority of score movements over the six months remained within a range of 20 points up or down. Some borrowers did see larger swings: Roughly 4 percent saw their FICO scores tumble by 40 percent or more, and about 6 percent saw their FICO scores climb by 40 points or more.
That could raise borrowing costs for an unfortunate few. "I think a 40-point reduction, depending on where you were to begin with, can put you into a higher interest rate category on new credit," says Sherry.
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