Måjðr Mïkê

If a little is good, is more better? Unless you can’t help but spend money you don’t have, the answer is yes. Here are 6 reasons high credit limits are helpful.

We’ve known the basics of how credit scoring works for nearly a decade now. Yet I still hear from readers who think they can improve their credit, or their finances, by closing accounts or having their credit limits lowered.

This behavior stems, I believe, from the still-widespread myth that you can have too much credit.

Here’s the reality: There’s no such thing as too much credit, unless you’re a debt addict. If that’s the case — if you’ve never seen a credit card you couldn’t max out — then this column is not for you. You should cut up your cards, seek counseling and pay off your debt.

Most people, by contrast, handle credit more or less responsibly. Forty percent of cardholders regularly pay their balances in full, according to Federal Reserve statistics, and half of those who do carry debt owe $3,000 or less.

It’s those folks I’m talking to. And I’ll say it again: There’s no such thing as too much credit, particularly these days.

Here’s why:

• Having "too much credit" isn’t a negative for FICO scores. You might get dinged for opening the accounts, but the FICO scoring formula (the one used by most lenders) doesn’t penalize you for having too many once they’re opened. If you get a score and are told the reason it isn’t higher is because you have "too much available credit," you probably didn’t get a FICO score but one of its competitors. "We just went through the full list of reason codes for FICO scoring, and it contains nothing remotely like ‘too much available credit,’" said Craig Watts, a FICO spokesman.
• Lots of available credit typically helps your credit scores. Once they’re established, credit accounts typically improve your scores as long as you don’t pay late or max them out. The FICO credit-scoring system is very sensitive to the gap between the credit you use and your available limits. The bigger the gap — on each account and overall — the better for your scores. Closing accounts or asking for lower limits shrinks that gap and can hurt your scores.
• Your income isn’t a factor. I’ve read a lot of well-meaning but completely inaccurate advice about how you should limit your available credit to a certain percentage of your income (with the percentage varying by how much credit the particular writer has). This is nonsense. Credit-scoring formulas don’t even take income into account.
• Lenders may care, but they probably won’t. Before the advent of FICO scores, many lenders were suspicious of those with "too much credit," worried these borrowers would suddenly rush out, max out their cards and then default. FICO’s research indicates this fear was overblown — if you’ve handled credit responsibly in the past, you’re likely to continue to do so — but some lenders are still wary. If you run into one of those, you can placate them by closing accounts, but you risk damage to your credit scores.
• Credit card issuers have gone a little nuts. In their efforts to reduce their risk, many credit card companies have been slashing limits, raising rates and closing accounts. Now they’re threatening to add new fees. (Read "Banks have declared war — on you.") Some have taken more-drastic steps by targeting not just risky borrowers but good customers who have always paid on time. The people who are in the best position to fight back are those who can simply take their business elsewhere. If you have plenty of other established accounts, you can start using them instead and transfer any balances. Also, a lower limit on one card isn’t a credit-scoring crisis if you have lots of other cards.
• You don’t need to worry that much about fraud. Yes, identity theft is a real problem, but if one of your existing accounts is hijacked, you’re not responsible for the bogus charges if you report them within 60 days. If you have so many accounts you can’t keep track of them, you may want to winnow the herd, but most people can remind themselves to log in to their accounts every month or so to check their charges.

I’m often asked how many credit cards are optimal. Alas, FICO is mum about that. But FICO does say the typical U.S. adult has four to five credit cards. And some of us have a lot more.

I hesitate to use myself as an example because individual experiences can vary so much with credit scoring, but at last count I had between seven and 17 open, revolving accounts showing on my credit reports at the three major bureaus. (The bureaus are private businesses in competition with each other, and the information they report is often different.) My FICO scores typically range from the high 700s to the low 800s (the top score is 850; anything over 760 or so typically wins the best rates and terms). Clearly, my scads of available credit aren’t hurting my scores.

What does ding your scores, as I’ve said, is opening and closing accounts and maxing out your cards. So use the following guidelines:

• Apply for credit sparingly. Applications are counted as "hard" inquiries and typically lower your scores. Although the damage of one inquiry is usually slight — 5 points or less — applying for a bunch of accounts in a short period could tag you as high-risk, because you’ll seem suddenly desperate for credit.
• Close accounts sparingly. If you decide you must close accounts, shut down retail accounts first (those department store cards you got because of discounts), and try to keep open your major credit card accounts, particularly those with the highest limits.
• Use only a small portion of your available credit. Whether or not you pay your balances in full each month — and you should — you still want to use only a fraction of your available credit: 30% or less is good, 10% or less even better. The balance that’s reported to credit bureaus and used in your scores is typically the balance from your last statement. If you used 50% or more of your limit, even if you paid it off in full, you could be hurting your scores.
• Push back against credit limit cuts. If you’re a good customer with high credit scores, point that out to the offending issuer. If it doesn’t reverse its decision, take your business elsewhere.

Published July 13, 2009

Bank customers used to the perks of free checking accounts — unlimited check writing, online banking, debit card use and ATM access, to name a few — might have to recalibrate their expectations soon. That’s because overdraft fees, which banks use to subsidize the expense of free checking accounts, have been under fire by consumer advocacy groups. (A quick primer: You spend $8 on lunch at Burger King and pay with your debit card. But there’s only $5 in your checking account. The transaction is still approved, but the bank slaps you with a hefty overdraft fee for the privilege.)

There have already been some changes to the way banks must disclose overdraft fees on statements, but now there’s a bigger push to require institutions to obtain accountholders’ permission before charging them overdraft fees on debit card purchases and ATM withdrawals. President Obama’s proposed Consumer Financial Protection Agency would likely address overdraft fees in some way.

Checking accountThat spells trouble for banks already hurting from the financial crisis. The bulk of revenue in bank retail deposits comes from penalty fees; economic research firm Moebs Services estimates that banks will rake in a total of $38.5 billion in overdraft revenue this year. In fact, a 2008 FDIC study concludes that 74% of all service charges on deposit accounts come from overdraft and insufficient fund fees, which typically range between $35 to $40 per incident. But there’s a small amount of consumers who shoulder most of the fee load: According to a May report from consulting firm Oliver Wyman, 68% of those fees come from just 5% of banking customers (who pay, on average, $1,614 each year). Meanwhile, 74% of customers pay no overdraft fees at all.

But with banks expecting roadblacks to fee income, some experts predict that the free-checking model might be on its way out. Aaron Fine, author of the Oliver Wyman report, recently told banking industry trade publication American Banker, “The industry has to change pretty dramatically because a substantial amount of the revenue that paid for free checking is likely to go away. That business model is not sustainable.”

For now, there are still plenty of free checking options out there, and many experts expect them to remain in some format so that banks can compete for customers. But Probity Financial Services, a small company based in Austin, Texas, partnered with Missouri’s Kennet National Bank in April to offer an alternative to those consumers who are tired of paying hundreds of dollars in overdraft fees each year. For $19.95 a month, you can set up a Probity online checking account that never charges overdraft fees, transaction fees, minimum balance fees and offers free online bill pay and ATM/debit card usage.

“We’re like Netflix for your checking account — you pay a fixed monthly fee and use it all you want,” says Probity CEO Tim Smith.

For those consumers who spend more than $240 a year on overdraft fees, Probity’s checking account is a good solution. Each customer is assigned an overdraft limit (no more than $500) based on credit and banking history. If the customer makes a purchase for more than what’s in his account, Probity covers the excess. To keep the account in good standing, the customer must deposit funds into the account within 60 days, or it will be closed. “The lion’s share of accountholders do bring the account into positive balance,” says Smith. He adds that most customers use direct deposit and typically just need the protection until the next paycheck comes in.

Still, $240 a year to avoid overdraft fees? Unless you’re one of those 5% of customers who spend more than $1,500 each year on those fees, there are still plenty of cheaper options to prevent overdraft pain. (And if you are one of those 5%, can you let me know how the heck that happened?) Many banks allow you to link your checking account to your savings account to cover overdrafts. And there are plenty of ways now to keep tabs on your account balances with email and text alerts. Free checking may be teetering, but it’s not going to vanish overnight.

Posted by Ismat Sarah Mangla
July 2, 2009 11:56 am

It may be only a matter of time before you get a notice in the mail stating that your credit card borrowing limit has been reduced. Already, some cardholders have had their credit lines slashed despite spotless payment histories and excellent credit scores.

About one in five cardholders had their credit limits reduced recently, according to a July survey by Consumer Action, a San Francisco-based consumer advocacy group. Roughly the same percentage of cardholders also reported being very close to their limit on at least one credit card, according to that survey.

Bankrate’s own survey indicates fewer Americans have been affected so far — 6 percent of respondents said their credit line was cut, up slightly from 5 percent in August. But some financial analysts predict the consumer credit contraction is on the verge of becoming severe. Meredith Whitney, a banking analyst at Oppenheimer & Co., predicts card issuers will cut credit lines by $2 trillion-plus over the next 18 months.

"Our surveys have been showing this as a practice (lowering card limits) for at least three years," says Linda Sherry, a spokeswoman for Consumer Action. "I think it is stepping up somewhat in this economy."

Some of the factors that could trigger a credit line decrease include a decline in cardholder credit scores, late payments and account balances that are too close to credit limits, according to Consumer Action’s 2008 credit card survey.

Federal law requires that you receive a notice in writing of a change in your annual percentage rates (APR) at least 15 days’ prior to the effective date, but the 15-day rule does not apply to credit limit changes.

If your credit card company lowers your limit, all is not lost. You may have options, including persuading the company to reverse its decision.

Complain diplomatically
Johann Beukes, a software engineering manager for Bankrate Inc. based in North Palm Beach, Fla., logged on to American Express’ Web site recently to make a payment and discovered his credit line had been reduced by $5,000, despite the fact that he’s been a cardholder for more than 10 years and has a credit score north of 800.

"I called them up the next day and asked why they were doing this, since we’ve never had a late payment," he says.

After lodging complaints with three company representatives, Beukes finally was told that his credit line was lowered because American Express wants to reduce its risk because of the credit crisis. Nothing personal.

Beukes gave up trying to restore his credit line — for now. "I was told that I should call back again in about six months and request an increase," he says.

While some card issuers won’t reverse their policy, it doesn’t hurt to try.

"The technique of complaining in this current environment is particularly effective because the card industry has a black eye right now," says Curtis Arnold, founder of Cardratings.com.

Arnold estimates it costs around $300 in marketing fees to replace a lost cardholder. He says you should ask to speak to a manager if you find you’re not getting anywhere with a customer service representative — just be sure not to lose your cool. As the saying goes, you catch more flies with honey than vinegar.

There’s no guarantee it will work, but if you’re a good customer, your chances of success are better. A good payment history with your card issuer, good credit and the ability to pay off your balance could tip the exchange in your favor. So can a mild threat.

"If you threaten to take your business elsewhere, they’re usually going to listen," Arnold says. "They’re hurting financially, and they don’t want to lose your business."

Transfer your balance
"If you have excellent credit, you may be able to get a balance transfer deal to another credit card with a higher limit," Consumer Action’s Linda Sherry says.

Bankrate can help you find a balance-transfer deal based on your credit rating.

Use balance transfers to your advantage, especially if you can qualify for a zero-percent or low-interest rate offer. But make sure you understand how balance transfer fees work and how long an introductory rate lasts.

If your credit card company charges 3 percent to transfer $5,000, it costs you $150. If you don’t pay off the balance before the introductory period is over, you’ll end up paying interest on that $150 as well.

Consider dusting off an alternate credit card if it has a favorable interest rate and a low balance.

"If you already have another card you are saving for a rainy day, use it occasionally, as it might not be renewed if it is inactive for long periods of time," Sherry says.

Make sure you read and understand the terms of any credit card offer. One late payment could result in your introductory rate skyrocketing to a much higher variable rate or a default interest rate.

Search beyond big banks
Despite the credit crunch, there’s a tremendous amount of competition for good-quality accounts, according to Tim Kolk, managing partner of credit card consulting firm Brookwood Capital.

If you’re unhappy with how you’re being treated by your present credit card provider, you can sift through a wide variety of consumer plastic in Bankrate’s credit card database to find a card that meets your needs.

There’s a catch, of course. Your consumer clout will depend on how good your credit score is. In today’s environment, you’ll need a score of at least 700 to get the best credit card deals, Kolk says.

Make sure you carefully monitor any offers that arrive in the mail and don’t hesitate to use a little legwork on top of an online search. Sometimes the best deals can be found right in your own neighborhood.

"I think someone who is having a little trouble with a major national card issuer would be well served to go to their local banks and credit unions," Kolk says.

He says local banks and credit unions tend to know their customers better, and they’ve historically had better credit performance — meaning fewer defaults — than the big credit card issuers.

"For a decade, credit union charge-off rates were about 2 percent, when big banks went from 4 to 6 percent or 7 percent and bounced around. So that’s a pretty compelling advantage," he says.

Learn to use credit more wisely
"The bottom line is, credit card companies are tracking our spending habits, our debt, etc. Consumers don’t need to freak out about that, but we do need to proactively manage our credit more than ever," says Curtis Arnold, founder of Cardratings.com.

If the limit on one or more of your credit cards is lowered, it may mean that card issuers are starting to view you as a greater credit risk.

Some card issuers are adopting complex credit-scoring models that take into account where you live geographically and the stores at which you shop. They also may be looking at whether you use your credit card to pay for things like groceries — a sign that you may be experiencing financial trouble.

Monitor your credit reports often. Because you can request a free report every 12 months from each of the three credit reporting agencies, rotate among them so you can check it every four months. Take a look at how many of your accounts, if any, have high balances in relation to your credit line and whether the report contains derogatory information, such as late payments.

These would be telltale signs that you are on the radar screen for a credit line decrease or a bump in your interest rate.

Try to pay off balances each month and read the printed material that comes with your monthly statements. Credit card issuers often slip in important information about your account along with marketing offers.

Be sure to monitor your balance and keep it under 30 percent of your credit limit to prevent further dings on your credit score. Avoid exceeding your limit, because that can cost you plenty in over-limit fees, says Consumer Action’s Linda Sherry. If that happens, you also may face a high default rate.

Be wary of closing accounts
If you close your account in retaliation to the creditor, you may only be hurting yourself.

One factor that affects your credit score is the length of time your accounts have been open, according to FICO. An account in good standing will fall off the credit report within 10 years. When it drops off, you could decrease the average of your accounts.

Rita Cheng, a Certified Financial Planner and financial adviser at Ameriprise Financial Services in Bethesda, Md., says she thought about closing her account after Citibank cut her credit line and almost doubled her interest rate.

"I’ve been a customer since 1990. I never pay late and my credit score is outstanding, so I thought this was crazy," Cheng says.

Cheng knew that closing her account in frustration could ding her credit score. Instead she made several calls to Citibank and worked her way up the customer service chain until she reached someone willing to work with her.

"I actually got a credit line increase and was able to get 2.99 percent (financing) for nine months on all new purchases," she says. "I did not have to apply for a new card, have people look into my credit report or get testy."

If you decide to close an account, make sure you have the financial wherewithal to pay off a significant portion of any balances that remain on other cards; otherwise, your utilization will go up.

If you don’t make any payoffs, you may cause a ripple effect with other card issuers that suddenly perceive you as a bigger risk, and you may end up with further credit limit reductions or rate increases.

Save more, carry less debt
For some consumers, lower card limits may be a blessing in disguise. Using cash or a debit card rather than a credit card certainly will help boost your bottom line by limiting your debt exposure.

Tim Kolk, managing partner of credit card consulting firm Brookwood Capital, says groups that are more susceptible to getting in over their heads in credit card debt likely will benefit most from lower card limits.

"I think some groups, like students, are still trying to figure out how this stuff works," he says.

Kolk believes other people, such as recent immigrants and seniors on fixed incomes, are susceptible to going over their limits and getting slammed with fees and higher interest rates because they don’t fully understand the way the credit card industry works.

"Overall, our society has abused credit," says Curtis Arnold, founder of Cardratings.com. "For folks carrying debt, reduced credit lines should translate into lower balances and lower consumer debt, which is a good thing — no doubt about it."

Steve Santiago

As High Scores Vanish, Borrowers’ Luck Runs Out

As banks tighten their lending standards, one number is playing an increasingly critical role in determining the financial fortunes of consumers: the credit score.

Lenders use them to decide whether to extend credit and at what interest rate. As lenders demand higher scores, more Americans are having trouble getting loans.

Others aren’t getting loans at all because their scores have dropped. They may have lost their jobs and not kept up with credit card and mortgage payments, or in some cases card companies have taken adverse actions against them. Eager to mitigate risks, card issuers have closed accounts or slashed credit lines, leaving customers with less available credit. Customers who have used up much of their credit then are closer to maxed out, which further hurts their scores.

To add to their crisis, people who try to take matters in hand and pay to find out their credit scores discover that it can be difficult to learn the score that lenders actually use to evaluate them.

"Credit scores have taken on a new degree of importance," said Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, an industry group. "In the past it was a question of ‘What will your interest rate be?’, and now it’s ‘Will you even get a loan?’ "

As a result, credit is less available to both low-risk and high-risk consumers at a time when they — and the economy — need it the most.

"The consumer who desperately needs credit right now is in a very bad situation," said John Ulzheimer, president of consumer education for Credit.com. "The consumer who is remaining consistent, the market is passing them by . . . You have more cars sitting on car lots and you have houses with for sale signs."

Jane Graver is one of those desperate consumers. She once had a credit score of about 700, which before the credit crunch made her a desirable candidate for a loan. Most lenders use the FICO score, which runs on a scale of 300 to 850.

Faced with a divorce, serious illness and tough economy, Graver, a small-business owner, missed a few credit card payments and used up her home-equity line of credit. She was close to being maxed out. Last year, her score dropped to the mid-500s.

Now that lenders are demanding credit scores of 720 or higher, she is considered even more of a risk and cannot get a mortgage — or even find a landlord willing to rent her a home. Her house in Orange, N.J., sold at a price high enough to cover her mortgage and line of credit, but she is struggling with what to do next.

"It is difficult to cope," said the mother of two. "I am absolutely unable to get a mortgage."

As scores become increasingly important, they have also become increasingly perplexing. Consumers have free access to the credit reports used to determine their scores, but they have to pay to check them. With the heightened interest, many borrowers have been doing just that, buying their scores from a variety of Web sites, only to find out that they might be different from the ones lenders use, according to bank officials and consumer advocates.

"One of the things consumers have to understand about scores is that there are a number of different scores within the marketplace," said Norm Magnuson, vice president of public affairs at the Consumer Data Industry Association, a trade group.

The FICO score, which was developed by a company formerly known as Fair Isaac, is the dominant player in the industry. It is calculated based on the information contained in credit reports, which list a consumer’s debts and payment history. Three bureaus — TransUnion, Experian and Equifax — keep those credit reports.

However, to compete with the FICO score, the three bureaus united in 2006 to create VantageScore, which ranges from 501 to 990, which they sell to lenders.

Complicating matters is that Experian and TransUnion have developed their own scores, which the agencies call educational scores because they are intended to help consumers gauge their own creditworthiness. Lenders cannot even buy Experian’s score. They can buy TransUnion’s but tend to go with the FICO score instead.

On its Web site, FreeCreditReport.com, Experian gives people their Plus score if they pay $14.95 a month for a credit-monitoring service, which they can cancel after a seven-day trial period. They have to dig through the terms and conditions before getting to this disclosure: "The PLUS Score is not a so-called FICO score, and may differ for a variety of reasons."

TransUnion also offers a $14.95-a-month credit-monitoring service with a 30-day trial period on TrueCredit.com. That gives consumers access to the bureau’s scores. Like Experian, TransUnion discloses on its Web site that its score is not the same as a FICO score.

Equifax gives FICO scores to anyone who pays $14.95 a month for its credit-monitoring service.

Susan Henson, a spokeswoman for Experian, said the educational scores are still a good tool for consumers even if they are not what lenders use.

"The most important thing is they’re really measuring the same thing, which is that consumer’s level of risk, whether they are an extremely low-risk consumer or whether they are a high-risk consumer," she said.

But some consumer advocates say the educational scores are of little use and too expensive.

Ulzheimer likens them to faux designer bags. "It’s like selling a Gucci bag on the streets of New York," he said. It looks like the real thing, but it’s not.

"It exposes something two of the three bureaus don’t want people to know," he added. "They make a whole lot of money selling scores."

Indeed, the recession has been a boon for many of the Web sites that sell credit scores. Traffic on FreeCreditReport.com, for instance, grew 6 percent, to 6.6 million visitors, in March, according to ComScore, which tracks Web sites.

Sean Craig, a retail manager in Ashburn, was one Experian customer. When he first checked a few months ago, his Experian score was 720. Then American Express lowered his Blue Cash card limit to $5,900 from $11,300. His score dropped to 683, then to 681. When he called American Express to ask why his limit had been reduced, he was told he had too much debt and that his credit score was actually 570.

Craig assumed the Experian score was the one American Express used, but American Express was looking at his FICO score.

"I was shocked when I checked and it was 683. I was even more shocked when I saw it was 570," Craig said. "It’s driving me nuts. The whole thing seems utterly arbitrary."

Such big gaps between the educational scores and the FICO scores are not unusual.

"It’s a real problem," said Evan Hendricks, author of "Credit Scores and Credit Reports" and editor of Privacy Times. "People are trying to be good, intelligent, educated consumers. They want to see their score, their report. Then they get a ‘fake-o’ score, which is most likely inflated, while the lender is using the FICO score . . . People think they’re better off than they are."

Adding to the confusion is that even FICO scores can vary. That’s because the company regularly updates the formula it sells to credit bureaus. The lenders can choose to buy the new or an older version of the formula, and they sometimes settle on an older version if it is cheaper and easier. "The lenders using scores from an older version, they’re not using bad scores," said Craig Watts, a spokesman for FICO. "They’re still doing the job but not doing it quite as well as the newer version."

Watts recommends getting FICO scores at Equifax.com or myFICO.com.

Other credit score experts said a better gauge of a consumer’s financial health is the credit report. If they have paid bills on time, have no negative public records such as bankruptcies, and have used less than 30 percent of available credit, they probably have a good score, Magnuson said.

It’s clear that’s no longer the case for many Americans.

The average TransUnion credit score was 651 in the first quarter of this year, the same as it was the fourth quarter of 2008. But that was a six-point drop from the previous quarter. Experian reported a 5-point drop in the VantageScore, from 751 in the fourth quarter of 2007 to 746 in the fourth quarter of 2008.

Equifax, however, reported an increase in average scores from May 2008 to this past May, from 699.8 to 701.9, which officials attributed to three factors. First, credit card issuers are taking on fewer new customers so there aren’t as many inquiries on consumers’ credit reports. Many inquiries hurt scores. Consumers are holding on to cards they have had for a long time, which helps scores. Lastly, more Americans are saving and not using credit.

Lower scores leave people such as Graver in a precarious position. She is struggling to make her online specialty tea business, DuckyLife.com, a success. To do so, she might need a loan someday, and she probably won’t qualify. But her most immediate worry is a home. To Graver, having a lower credit score is "a nightmare."

I’ve "survived four life-threatening illnesses, six surgeries, divorce — and all as a single mom," she said. "Now I cannot find a place to live."

By Nancy Trejos
Washington Post Staff Writer
Sunday, June 21, 2009

June 30 (Bloomberg) — When Sharii Rey, a paralegal in Portland, Oregon, had her credit limit reduced by JPMorgan Chase & Co. earlier this month, she said it would hurt her 760 credit score. That’s not the bank’s problem, she was told. It’s FICO’s.

After Rey’s $42,500 credit line was cut to $12,000, her debt relative to available funds almost quadrupled. This so- called utilization rate is a large component of the FICO formula and a higher ratio can lower a score. Rey, 62, is concerned a new FICO score will squash her ability to borrow.

Congressman Luis Gutierrez, an Illinois Democrat, says the FICO formula, the most widely used by U.S. lenders, has flaws as banks decrease loans to consumers, regardless of individual risk profiles. At least 30 million Americans had their credit limits reduced arbitrarily during the second half of 2008, FICO estimates. In the first quarter, New York-based JPMorgan and Citigroup Inc. and Bank of America Corp. in Charlotte, North Carolina, slashed $320 billion from credit lines, according to a report by former Oppenheimer & Co. analyst Meredith Whitney.

“Reductions to a consumer’s line of credit based upon the lending institutions’ overall appetite for risk has little or no bearing on a consumer’s own risk of default,” said Gutierrez, chairman of the House Subcommittee on Financial Institutions and Consumer Credit.

An individual’s FICO score is based on factors that aren’t directly related to JPMorgan’s decision to lower a credit limit, said Paul Hartwick, a spokesman for the biggest U.S. bank by market value.

Scaled-Back Lending

Banks have scaled back lending during the deepest U.S. recession in five decades. The Federal Reserve’s quarterly survey of senior loan officers released May 4 showed about 65 percent of banks lowered credit limits on new or existing credit-card customers, compared with 45 percent in the January survey. Consumer credit, which includes credit card and auto loans, was $2.52 trillion in April, according to a Fed report released this month.

“The collapse of the economy raises serious questions about the credit industry’s reliance on credit scores,” said Ed Mierzwinski, consumer program director at the U.S. Public Interest Research Group in Washington. “Are the scores as predictive as FICO swears they are?”

Scores based on models established by Minneapolis-based FICO, formerly known as Fair Isaac Corp., are used to gauge a consumer’s financial health. The scores, which range from 300 to 850, affect the ability to get credit cards, mortgages and insurance products, as well as the rates borrowers pay for them.

Founded in 1956

FICO was founded by Bill Fair, an engineer, and Earl Isaac, a mathematician, in 1956 and the FICO score is now used by 90 percent of the 100 largest U.S. banks. Mortgage lenders use the scores, which rank borrowers according to the likelihood of default in the next 24 months, in more than 75 percent of all residential mortgage originations, according to FICO.

“FICO scores have held up quite well in terms of predictive accuracy,” said FICO Chief Executive Officer Mark Greene, 54, a former economist at the Fed. “It’s not obvious to me that having the score change because of limit cuts is the wrong thing. The bank’s action may signal a riskier environment and the view that you are a riskier consumer.”

Mortgage-finance companies Fannie Mae and Freddie Mac use FICO scores when backing loans, which helps FICO keep its market dominance, said Ken Lin, chief executive officer and founder of San Francisco-based Credit Karma Inc., a Web site that offers free credit scores to consumers.

Fair’s Couch

Experian Group Ltd. in Dublin, Equifax Inc. of Atlanta and Chicago-based TransUnion LLC have their own versions of the FICO model that they sell to lenders. FICO relies on data from the companies to create its formulas.

The formula, which evaluates payment and credit history, utilization, new loans and types of credit in use, is updated every two to three years, said Ethan Dornhelm, who works with about 40 FICO scientists in San Rafael, California, about 30 minutes north of San Francisco. Fair’s leather tobacco-colored couch, where he used to lie in the 1970s while devising the model, is displayed in an office lobby.

The FICO 08 system, introduced in May 2007, refines previous models by limiting the effect of authorized users who artificially increase scores and separating chronic late payers from consumers who have isolated late payments, said Lisa Nelson, FICO’s vice president of global scoring. Borrowers who have higher utilization rates will receive fewer points, she said.

‘Fear for Enamel’

Rey, the paralegal, said she was counting on a credit “cushion” in case she was affected by the decline in the economy. She said she fears she won’t be able to buy a new home and car because her reduced FICO score will mean higher interest rates on the loans.

“I have been gritting my teeth so hard, I fear for the enamel,” Rey said.

Nationally, FICO score distribution has remained fairly stable with the median at about 720, according to a FICO study of Equifax data. Consumers are monitoring their spending habits more closely, said Tom Quinn, vice president of scoring at FICO.

Credit-limit cuts that didn’t follow customer actions such as late payments affected about 11 percent of consumers from April to October 2008, according to the FICO study. The median FICO score for this group was unchanged at 770, Quinn said.

Limits Running Down

“The emphasis on utilization rates when you’re not running up debt and instead limits are running down makes FICO scores much less reliable,” said Josh Frank, a senior researcher at the Center for Responsible Lending in Durham, North Carolina.

Ken Jett, a 42-year-old licensed mental-health counselor, keeps his 12 credit cards in his desk. He said he hasn’t used them since February because he’s concerned about his credit score that has already dropped to 683 from 720.

“My score is no longer a good glimpse of who I am, credit- wise, because it looks like my cards are maxed out and I’m a risky borrower,” said Jett, who’s based in St. Louis. “But nothing has changed in my credit-risk profile except for an arbitrary $25,000 limit cut.”

Job Losses

Gutierrez, the congressman, said he’s planning a subcommittee hearing on credit scores before the end of the year.

FICO’s first-quarter revenue from scoring operations fell 21 percent to $31.1 million from a year earlier, as fewer consumers applied for mortgages, auto loans and credit cards. Almost 550 FICO employees have lost their jobs since 2008 as earnings decreased, said Craig Watts, a company spokesman. The stock rose 5 cents to $15.46 at 4:01 p.m. in New York Stock Exchange composite trading. It has declined 8.3 percent year to date.

“Is FICO an accurate predictor of risk?” said Evan Hendricks, publisher of “Privacy Times,” a Washington-based newsletter and author of “Credit Scores & Credit Reports.” “It’s the worst system around, except for all the rest,” said Hendricks, taking a line from former U.K. Prime Minister Winston Churchill.

To contact the reporter on this story: Alexis Leondis in New York aleondis@bloomberg.net.
Last Updated: June 30, 2009 17:00 EDT