Reductions in credit card limits impacts ability to borrow
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There's nothing new about lenders reducing credit lines and closing accounts for risky customers. But as credit card losses have risen to record levels in recent months, banks have been slashing available credit for even those in good standing -- and that could hurt those customers' FICO scores.
A recent study by the Fair Issac Corp., which created the best-known and most widely used credit score model that lenders use to make decisions, shows credit card issuers cut limits for an estimated 33 million cardholders between October 2008 and April 2009.
Although it's hard to make a general conclusion that FICO scores are hurt in every scenario in which credit limits have been cut, in most cases if someone's credit limit is reduced or an account is closed, it will raise that individual's debt ratio and effectively cause the score to drop.
"It's really that big banks are trying to protect their bottom lines," said Ben Woolsey, director of marketing and research for CreditCards.com in Austin, Texas. "Until the unemployment rate starts coming back down, I don't think you'll see card issuers be more generous with credit lines."
With the possible exception of a person's Social Security number, the credit score might be the most important number in his or her life. It affects every area of personal finances: interest rates paid on loans, premiums for insurance and in some cases whether someone qualifies to get a job in an already tough job market.
Credit industry experts say that when a cardholder uses more than 30 percent of the available credit, it lowers the FICO score. Lenders usually establish score cutoffs to determine to whom they are willing to lend.
Stacy Francis, president of Francis Financial in New York, recently ordered credit reports for every one of her clients. Many have much lower FICO scores this year versus last year because of having their limits lowered and accounts closed by credit card companies.
"I had a client try to get a home equity loan from Bank of America and they discovered that, in general, to be considered they needed a 740 FICO score," Mrs. Francis said. "That's the new good credit score. A year ago, they could have gotten the same loan with a 690 score. It's a whole new world."
FICO representatives could not be reached for comment for this report, but the company recently released a study in which it analyzed data to see how recent credit line decreases and account closures have affected scores.
It found issuers cut credit limits for 33 million credit cardholders. About 24 million of those customers had their limits reduced despite a good credit history.
Researchers found credit reports for the other 9 million or so consumers contained recent negative credit references such as "late payments," and those triggers may have prompted lenders to cut them off.
For the bulk of its study, FICO focused on the first group, those whose credit limits were reduced despite having any recent risk triggers.
Cardholders in this group had a median score of 760 on a range of 300 to 850. Roughly one in five had a reduction of an average $5,100 in revolving credit. The drop in scores for most people in this group was usually less than 20 points, the study said.
A recent poll by CardRatings.com, based in Little Rock, Ark., offered a different perspective on the FICO study. Of the 810 consumers who responded, 411 poll-takers -- or 51 percent -- indicated that their credit lines had been lowered during the past 180 days.
"I find the fact that over 50 percent of our respondents have had a line cut in the past six months is very disturbing," said Curtis Arnold, founder of CardRatings.com. "Unfortunately, I don't think we've seen an end to this trend.
"The very aggressive credit line decreases we've seen recently, as evidenced by this poll, create a real double whammy for consumers," Mr. Arnold said. "The most obvious blow is that your spending ability and access to credit takes a hit. Perhaps more importantly, your credit score can take a nose dive."
Major credit card issuers have seen increasingly higher numbers of defaults since the onset of the Great Recession, which suggests consumers are still under enormous financial stress and card issuers have good reason to remain fearful of high debt exposure.
Bank of America said its charge-off rate -- loans the company does not expect to be repaid -- rose to 14.54 percent in August from 13.21 percent in July. Citigroup, reported its charge-off rate rose to 12.14 percent in August from 10.03 percent in July. Discover Card delinquencies increased to 9.16 percent from 8.43 percent.
Many analysts expect the bad loan loss levels to keep rising until later this year or early 2010.
"Banks are hurting, and it's having a significant impact on our economy," said Bill Hardekopf, CEO of www.LowCards.com, an independent Web site that helps consumers compare credit cards. "Issuers are trying to limit their risk.
"People were approved for credit who should not have been when times were good. Now banks are eliminating risky and dormant accounts." Mr. Hardekopf said credit card companies are especially nervous about dormant accounts because customers may start using them as a last ditch effort before bankruptcy.
In the end, customers with good credit histories -- but whose accounts are closed or reduced -- could end up paying higher interest rates on mortgages or automobile loans.
"Consumers are paying the price because credit card companies are for-profit institutions and they are looking out for themselves before the consumer," said Mitch Franklin, assistant professor of accounting at Whitman School at Syracuse University.
First Published September 18, 2009 12:00 am