The Credit Crunch’s Impact on Credit Scores

One of the things I enjoyed about working with credit scoring in a prior job was the utter beauty of the interrelationships of the different variables coming together to make a prediction.  When you consider that beyond delinquency information, scoring relies on utilization, stability and breadth of credit, questions like “what happens to my score if I apply for a new credit card” become beautifully complex.

Similarly, one of the lessons I learned in that job was “watch out for the impact of economic changes on your credit model”.  While that’s a subject that has been reasonably well-hashed-out for banking and lending purposes, both domestically and internationally, American usage of credit data for insurance purposes is still comparatively new.  The current crunch is arguably the first test of the interrelationship between scoring and predictiveness.

So, it is with some interest that I notice a wire service story came out this weekend on how credit issues are starting to be reflected in (banking) credit scores:

At the same time, revolving credit usage — which includes credit cards — accelerated sharply to a year-over-year growth rate of about 8 percent in recent months. That’s the fastest rate in seven years and well ahead of the 2 to 3 percent rate of growth from 2004 through 2006 when home equity lines of credit were a bigger source of cash for consumers, according to Merrill.

But as credit cards are used more frequently, that often results in bigger balances left on the cards. What’s worrisome is that consumers who are faced with a number of ugly economic scenarios hitting at once — falling home prices, surging commodities costs and a weak job outlook — won’t be able to pay their bills.[…]

[C]ard companies including Washington Mutual, HSBC and Wells Fargo are lowering their credit limits, according to data from the consulting firm Institutional Risk Analytics.  Consumer advocates aren’t saying that is bad news — in fact, they believe it helps prevent cardholders from overextending themselves and is preferred to having a sudden surge in card interest rates. […]

Let’s say a cardholder has a credit limit of $10,000 and a balance on the card of $4,000. The card company worries that large balance may increase the prospects for default, so it lowers the credit line to $5,000. But in doing that, it completely changes what is known as the credit utilization rate, raising it from 40 percent to 80 percent. That is then factored into the calculation of one’s so-called FICO credit score, which measures creditworthiness, according to Craig Watts, a spokesman for FICO-creator Fair Isaac Corp.