Here’s a homeowner credit torture scenario that might have happened to you, and now has a major real estate lobby on Capitol Hill demanding immediate reforms.
Say you’ve had a solid payment record on just about all your accounts — three credit cards, your first mortgage, home equity line and other important monthly bills. The last time you checked, your credit scores were comfortably in the 750s.
Suddenly you get a notice from the bank that because of “market conditions,” your equity line limit has been cut from $60,000 to $35,000, slightly above the $30,000 balance you’ve got outstanding. Then one of your credit card issuers hits you with more bad news: Your $20,000 limit has been reduced to $10,000. Your balance on the card, meanwhile, is about $9,000.
Guess what happens to your credit scores in the wake of the bank cuts? You might assume that nothing happens; you haven’t been late, you haven’t missed a monthly payment. You’re a good customer.
Wrong. Depending upon your overall financial situation, your credit scores could plunge into the upper 600s. This in turn could put you out of reach for a refinancing at a favorable interest rate or hamper your ability to buy a new home and sell your current one.
The reason for the score plunge: With the reductions in your line limits, you’re now much closer to being maxed out. You are using a higher percentage of your available credit — $30,000 of the $35,000 revised limit (86 percent) on your home equity line, and $9,000 of the $10,000 limit (90 percent) on your card. Credit scoring models typically penalize high utilization rates because they are statistically correlated with future delinquency problems.
No one ever warned you about this — certainly not the banks that cut your credit. Now the largest lobby group on Capitol Hill, the 1.1-million-member National Association of Realtors, is demanding that the creator of the FICO score that dominates the mortgage market — Fair Isaac Corp. — take immediate steps to lessen the negative impacts on consumers when banks abruptly cancel or slash credit lines of non-delinquent customers.
In a major policy move, NAR is calling upon Fair Isaac to “amend its formulas to avoid harming consumers whose utilization rates increase because their available lines of credit [are] reduced” despite on time payment histories. The group wants FICO to either ignore the utilization rate altogether for such consumers or to compute the score as if the credit max had not been reduced.
Ron Phipps, president of the association, said “we’re seeing this across the country and it is hurting people who are responsible users of credit.”
Tom Salomone, broker-owner of Real Estate II in Coral Springs, Fla., said “there’s absolutely no question these credit card and home equity line reductions are killing [homebuying] deals, and arbitrarily raising interest rates on people.”
In an interview, Salomone said he has seen many situations where homebuyers lost 20 to 30 points on FICO scores “but had done nothing wrong — the banks just lowered their lines.” He added that the inability of FICO’s software to distinguish innocent victims from people whose behavior actually merits credit line reductions demonstrates that “FICO’s model is archaic.”
Asked for a response, Joanne Gaskin, Fair Isaac’s director of mortgage scoring solutions, said the FICO model attaches such importance to consumers’ available credit and utilization rates — they account for 30 percent of the score — because they are highly accurate predictors of future credit problems.
Research conducted by Fair Isaac last year found that consumers who utilize 70 percent of their available credit “have a future bad rate 20 to 50 times greater than consumers with lower utilizations.” Ignoring this key indicator, the study said, would “decrease [the score’s] predictive power.”
NAR has also asked Fair Isaac to help out with the nationwide foreclosure crisis by revising its model to “recognize” lender codings on credit file accounts indicating that homeowners had received loan modifications approved under federally backed programs. Rather than treating borrowers’ reduced post-modification payments as ongoing evidence that the mortgage was “not paid as originally agreed” — which depresses scores sharply — the association said FICO scores should reflect the reality that the lender agreed to lower payments and borrowers are making payments “as agreed.”
The real estate association also said it plans to push for legislation in the upcoming congressional session to provide free credit scores — one each from Equifax, Experian and TransUnion, the national credit bureaus — every time a consumer orders annual free credit reports.
Ken Harney is a real estate columnist with the Washington Post.