July 12, 2010 in Nation/World

Credit scores sink, compounding slow recovery

Eileen Aj Connelly Associated Press

Tags: credit economy

NEW YORK – The credit scores of millions more Americans are sinking to new lows.

Figures provided by FICO Inc. show that 25.5 percent of consumers – nearly 43.4 million people – now have a credit score of 599 or below, marking them as poor risks for lenders. It’s unlikely they will be able to get credit cards, auto loans or mortgages under the tighter lending standards banks now use.

Because consumers relied so heavily on debt to fuel their spending in recent years, their restricted access to credit is one reason for the slow economic recovery.

“I don’t get paid for loan applications; I get paid for closings,” said Ritch Workman, a Melbourne, Fla., mortgage broker. “I have plenty of business, but I’m struggling to stay open.”

FICO’s latest analysis is based on consumer credit reports as of April. Its findings represent an increase of about 2.4 million people in the lowest credit score categories in the past two years. Before the Great Recession, scores on FICO’s 300-to-850 scale weren’t as volatile, said Andrew Jennings, chief research officer for FICO in Minneapolis. Historically, just 15 percent of the 170 million consumers with active credit accounts, or 25.5 million people, fell below 599, according to data posted on Myfico.com.

More are likely to join their ranks. It can take several months before payment missteps actually drive down a credit score. The Labor Department says about 26 million people are out of work or underemployed, and millions more face foreclosure, which alone can chop 150 points off an individual’s score. Once the damage is done, it could be years before this group can restore their scores, even if they had strong credit histories in the past.

On the positive side, the number of consumers who have a top score of 800 or above has increased in recent years. At least in part, this reflects that more individuals have cut spending and paid down debt in response to the recession. Their ranks now stand at 17.9 percent, which is notably above the historical average of 13 percent, though down from 18.7 percent in April 2008 before the market meltdown.

There’s also been a notable shift in the important range of people with moderate credit, those with scores between 650 and 699. The new data shows that this group comprised 11.9 percent of scores. This is down only marginally from 12 percent in 2008, but reflects a drop of roughly 5.3 million people from its historical average of 15 percent.

This group is significant because it may feel the effects of lenders’ tighter credit standards the most, said FICO’s Jennings. Consumers on the lowest end of the scale are less likely to try to borrow. However, people with midrange scores that had been eligible for credit before the meltdown are looking to buy homes or cars but finding it hard to qualify for affordable loans.

Workman has seen this firsthand.

A customer with a score of 679 recently walked away from buying a house because he could not get the best interest rate on a $100,000 mortgage. Had his score been 680, the rate he was offered would have been a half-percent lower. The difference was only about $31 per month, but over a 30-year mortgage would have added up to more than $11,000.

“There was nothing derogatory on his credit report,” Workman said of the customer. He had, however, recently gotten an auto loan, which likely lowered his score.

Studies have shown FICO scores are generally reliable predictions of consumer payment behavior, but Workman’s experience points to one drawback of credit scoring: lenders can’t differentiate between two people with the same score. Another consumer might have a 679 score because of several late payments, which could indicate he or she is a bigger repayment risk.

On a broader scale, some of the spike in foreclosures came about because homeowners were financially irresponsible, while others lost their jobs and could no longer pay their mortgages. Yet both reasons for foreclosures have the same impact on a borrower’s FICO score.

In the past too much credit was handed out based on scores alone, without considering how much debt consumers could pay back, said Edmund Tribue, a senior vice president in the credit risk practice at MasterCard Advisors. Now the ability to repay the debt is a critical part of the lending decision.

Workman still thinks credit scores alone play too big a role. “The pendulum has swung too far,” he said. “We absolutely swung way too far in the liberal lending, but did we have to swing so far back the other way?”

Seven comments on this story so far. Add yours!

spokanecougar on July 12 at 1:50 a.m.
What is sad is these huge Wall Street banks that got bailed out by both Bush and Obama with our tax payer money and they still wont lend to anyone. They have made billions and billions of dollars on people losing money, houses and everything else yet they still will not loan to anyone unless your like Bill Gates or Warren Buffet. Sad. What greedy horrible nasty disgusting people these are running these banks with out a care for anyone but themselves and their fellow crooks.
IHike4Fun on July 12 at 7:48 a.m.
After taking the Dave Ramsey (Financial Peace University) course I decided to stop using a credit card for purchases or taking out loans for things. Strictly cash/debit card only for this kid (including big things like cars). I even cancelled my last credit card.

Your credit score is based on your credit card usage and how many loans you have taken out. Since I am no longer taking out any loans and don't have any credit cards I fully expect my credit score to drop until it can't even be calculated any more. Does that concern me? Not in the least. Will that include me in the group this article is talking about? Yep. Is that a problem? Not to me. In my case it is a sign of very good financial health.

I just wish I had discovered Dave's course a long time ago. I could have saved a LOT of $$ wasted on credit card interest, car loan interest and home equity line of credit interest.
Lewis on July 12 at 8:49 a.m.
the idea you need credit in this country is a scam. it is a way to keep tabs on you and judge accordingly.

I have no credit cards of any kind i only use cash. if i can not afford it i don't buy it. i have no debt other then my mortgage.

I do not believe in banks and therefore have no savings or checking in a bank.

all savings are in gold and it is in a secured vault.
Lewis on July 12 at 8:51 a.m.
several years ago i made a pac with the banks i wont expect them to give me customer service and they wont steal any more of my money.
Mr. Natural on July 12 at 9:55 a.m.
LOL…good one Lewis!

Heck I know folks who have filed bankruptcy (even twice) and still got home and auto loans…

I don't pretend to understand the world of high finance but these financial institutions create their own bilk systems around credit scores just to increase people’s interest rates
flutieflakes on July 12 at 12:00 p.m.
So you're saying that my crappy credit is actually decent in comparison to that of everyone else? Best news I've heard all morning.
MelodyK on July 12 at 12:23 p.m.
Credit is a real factor in financing and a lack of education on how credit works and how your decision making affects your credit score can be a detriment. There's no substitute for learning how something works and attaining the skills to use your credit instead of being used by it. Whether you finance items or not, knowledge is power.

I'm glad to see an article like this, I teach credit, financial fitness and mortgage classes and I am a certified housing counselor. I would be as lost as a lot of people I work with if I didn't have this training and if I knew then what I know now, I would have made a lot of different choices with my credit and finances. This kind of education should be a basic requirement in high school.