Banks Teaching the Futility of Chasing Credit Scores

March 10, 2009 by  
Filed under Debt and Credit

Banks and other lenders are now teaching many of us a lesson.  The lesson is the futility of focusing on credit scores as a financial planning strategy.

You probably know what I am talking about.  Consumers have been afraid of closing unused credit card accounts because it will reduce the amount of “available” credit which can negatively affect your credit score.  Some people open new credit card accounts for the same reason, to increase their available credit and their scores.

There are websites dedicated to describing different tactical score-boosting moves.  And, of course, there are plenty of opportunities for consumers to pay the credit score industry for the ability to monitor their scores on a daily or even real-time basis. 

Lately, banks and other lenders have decided to take matters into their own hands.   Consumer credit accounts – including credit cards and HELOCs – are being reduced or even closed out by the lenders.  It does not matter if the consumer has been a 100% responsible borrower, with no late payments and manageable debt loads.  Banks are arbitrarily closing or reducing lines of credit to simplify and lower the risks of their own lending portfolios.   Those precious credit scores are being damaged even though the consumer did nothing but obediently follow the credit score rules.

According to this article from the U.S.A. today, the median credit scores dropped by 5 points nationally in 2008.  In parts of California, Arizona, and Florida, the median scores fell by 17, 14, and 12 points respectively.  Again, these declines are primarily attributable to actions by credit providers, not credit users.

Part of the problem is that many lenders originally used poor underwriting standards or processes when the credit lines were first extended.  Now these same lenders are re-visiting what they did initially and making adjustments.  A consequence of the banks’ credit “do-over” strategy is that the borrower’s apparent credit worthiness falls.  Because the tentacles of the credit score reach into all aspects of our financial lives, we suddenly become less worthy.  Costs of credit and insurance go up.  A rapid decline in median credit scores is nothing to joke about for a lot of people who are affected.

Part of me wants to say “I told you so” because Mr. ToughMoneyLove has been preaching against credit-score centric behavior for a long time.  On the other hand, something positive can come out of this lesson.  Some consumer advocacy groups and even politicians are paying attention and talking about intervening.

Generally I am opposed to government intervention into our financial affairs.  But if intervention can reduce the influence of the credit score in our financial lives, I am all for it.  Such diminished influence will allow us to direct our money energies at things that really matter, like building and preserving wealth.  An intervention that breaks a cycle of credit score addiction can be a good thing.

What are your thoughts on what is happening with credit scores?  Do you think the government should intervene and regulate the credit score system?


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Comments

7 Responses to “Banks Teaching the Futility of Chasing Credit Scores”
  1. I agree. I think it’s ridiculous that we should have to worry about so many arbitrary things affecting our credit score. I have two credit cards, both with high limits. I really only use one of them, but keep the other one open because it’s a large piece of my available credit puzzle. This seems like such an arbitrary way to determine anything, but of course I play the game anyway.

  2. Kacie says:

    I hate that I have to use credit to keep my score high. I haven’t used a credit card since I paid them all off more than a year ago, but I still have a car loan so I guess that’s what’s keeping it solid.

    I don’t like debt (who does?) and I want to keep my score good so my insurance rates don’t jump. And when I eventually buy a house, I definitely want to get a good interest rate on a mortgage.

  3. MasterPo says:

    Reminds me of all the emphasis put on SAT scores. Everyone (well most anyway) will give lip service to say how the score by itself has little meaning. But then they put soooo much weight on students with higher scores, often just marginally higher than others.

  4. Roger says:

    MasterPo beat me to it; the problem with credit scores is the same problem as SAT scores. Although just about everyone agrees that these scores do not provide a thorough and complete picture of someone’s financial or academic state, they get used anyway. It’s much less effort to just glance at a single three or four digit score and make all your decisions about someone based on that.

    I think that credit scores either need to become a much less important part of our financial lives, or there needs to be a dramatic reworking of how credit scores are calculated so that it more accurately reflects the real risks of lending to someone.

  5. kitty says:

    There are some problems with credit scoring. For example, why don’t they include paid off loans in the score? Like why paid off mortgage counts for less than an existing mortgage? Ditto with closed credit cards. Of course, if someone gets a complete credit report, they’ll get all the history including paid off mortgage and closed credit cards, but if someone just checks the number, the closed accounts aren’t counted. Why? Logically, the length of history shouldn’t be based only on opened accounts. It should include closed accounts as well. If I were a lender I’d be just as interested in closed accounts as in opened accounts.

    I don’t have a problem with having a credit score: lenders and landlords need to have some way to determine how risky someone is. But a) credit score should be only one of items to consider b) one should look at complete credit history, not just a number.

  6. kitty says:

    There are some problems with credit scoring. For example, why don’t they include paid off loans in the score? Like why paid off mortgage counts for less than an existing mortgage? Ditto with closed credit cards. Of course, if someone gets a complete credit report, they’ll get all the history including paid off mortgage and closed credit cards, but if someone just checks the number, the closed accounts aren’t counted. Why? Logically, the length of history shouldn’t be based only on opened accounts. It should include closed accounts as well. If I were a lender I’d be just as interested in closed accounts as in opened accounts.

    I don’t have a problem with having a credit score: lenders and landlords need to have some way to determine how risky someone is. But a) credit score should be only one of items to consider b) one should look at complete credit history, not just a number.
    P.S. – Sorry, forgot to tell you great post!

  7. MasterPo says:

    Be it FICO scores, SAT scores, whatever – the whole world is looking for one indicator, one mark that will summarize an avalanche of information.

    Sounds like a great idea – on paper.

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