Withheld credit limits hurt consumers

Nation's Housing

October 24, 2004|By KENNETH HARNEY

NEW RESEARCH by the Federal Reserve Board should set off alarm bells for anyone considering applying for a home mortgage. Behind your back, your credit card company could be hurting your credit standing by withholding key information from the national credit bureaus.

That could depress your credit scores and raise the interest rate you're charged on your home loan.

Three Federal Reserve staff economists studied a nationally representative, random sample of the credit files of 301,000 people and found that 46 percent had files from which at least one credit limit had been withheld by a creditor.

Why is that significant? Say you finished school a couple of years ago, you've got a good job and you're beginning to establish a solid credit history. You have one credit card with a $2,500 limit. You run a modest monthly balance averaging $250. You've never been late, never missed a payment. You're an excellent customer.

But unknown to you, your card issuer has a policy of not reporting fully the details of its customers' accounts. In your online national credit file, your monthly balances and payments are reported accurately. But your credit limit is left blank.

Your card issuer does that to stymie competitors who routinely troll through the databases of the national credit bureaus for new accounts by ordering up lists of consumers with specified characteristics.

For instance, a competing card issuer might troll for consumers living within a ZIP code area who have credit scores above a given threshold. The company might also seek consumers with young-looking "thin files" containing a handful of credit account trade lines.

The problem is that one of the heavily weighted factors in most credit scores - whether the FICO (Fair Isaac & Co.) score or the credit bureaus' proprietary scores - is "utilization" of credit. If you are making heavy use of your credit accounts, you are considered a greater risk of future default. Your scores go down.

To measure utilization, scoring systems look at the ratio of your highest balance to your credit limit. If you had a $2,400 high balance against your $2,500 limit, you'd have a very high (96 percent) utilization ratio. The scoring program would penalize you for being nearly maxed out.

However, your $250 balance against your $2,500 limit produces a low (10 percent) ratio, and the scoring system should reward you for your prudent use of credit.

The score killer results when a creditor reports no credit limit on an account, making calculation of a utilization ratio impossible.

Confronted with missing credit limits, most credit scoring systems "substitute the highest balance for the missing credit limit," according to Federal Reserve researchers, "The typical result," said the Fed, is higher credit utilization ratios "than if the credit limits had been reported."

Artificially inflated ratios typically depress credit scores, sometimes by 50 points or more, according to credit industry experts. The effect can be more pronounced when the loan applicant is young or relatively new to the world of credit.

The Fed researchers did not identify the credit card issuers that intentionally withhold customers' limits. But for 46 percent of the consumers in a random sample of 301,000 credit files to be affected by this score-depressing policy, the creditors involved must be numerous, big or both.

Consumer advocates are outraged at the practice. "I think they are basically intentionally harming their own customers," said Evan Hendricks, author of Credit Scores & Credit Reports and editor of the newsletter Privacy Times.

Ed Mierzwinski, consumer program director of U.S. Public Interest Research Group, said that "credit card companies wouldn't be incompletely reporting [credit limits] if they didn't think it deflated their customers' scores" and rendered cardholders less attractive to poaching competitors.

Excluding credit limits can cost the consumer hundreds of dollars a month and thousands of dollars a year. According to Fair Isaac, a 677 FICO score in today's market would qualify a borrower for a 6.23 percent 30-year fixed rate on a $150,000 home loan. A 30-point drop in that score because of nonreporting of credit limits would push the best rate available to 7.38 percent.

Monthly principal and interest payments for the applicant with the artificially depressed score would be $115 a month higher.

Battling nonreporting in a voluntary credit system is easy. Ask your credit card issuers whether they report credit limits. Or get a copy of your credit file online (typical cost $9.95), and check on whether your limits are listed.

Then cancel all the cards that intentionally depress your credit scores.

Ken Harney's e-mail address is kenharney@earthlink.net.

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