FICO Scores are Declining

This week there have been reports that credit scores of millions of Americans have been sinking to new lows.  Fair Isaac recently reported that 25.5 percent of consumers — nearly 43.4 million people — now have a credit score of 599 or below.  FICO's findings show an increase of about 2.4 million people in the lowest credit score categories over the past two years.

The people that seem to be most affected in this downward shift are those with moderate credit scores ranging between 650 and 699. The new data reflects a drop of roughly 5.3 million people in this credit range. This is significant because people with moderate credit scores have felt the greatest effects of tighter credit standards.  The FICO score is a predictive tool that evaluates the risk to a lender of a potential borrower at a given time.  A very common, yet not entirely obvious, cause is an increased utilization ratio; that is the ratio that measures how much of your credit you are using in relation to your total available credit.  Research has shown that people who are using more of their available credit are more likely to miss future payments than those people using very little of their available credit.  The lower this ratio, the better the FICO score.  So, as lenders cut back on available credit to certain customers, the utilization ratio increases and scores tend to go down.  There has been a fair amount of debate as to whether arbitrary reductions of credit lines and credit card limits should be reflected in FICO scores. “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 Luis Gutierrez, chairman of the House Subcommittee on Financial Institutions and Consumer Credit.  But according to FICO Chief Executive Officer Mark Greene, “…The bank’s action may signal a riskier environment and the view that you are a riskier consumer.” (Bloomberg.com, June 39, 2009, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aedS3XGrNmSA). This week’s news of the continued significant declines in FICO scores and the effects on the US economy will certainly add fuel to this debate.