Banks intentionally lower credit scores

We are still lending in cash! It is amazing that the federal reserve has flooded the markets with cash enabling banks to borrower at historic rates.  Furthermore, banks are considerably healthier today than they were in 2008.  Unfortunately, this is not translating to increased lending; just the opposite is occurring and banks are taking steps that will lower credit scores. Why? How will you be impacted?

How are credit scores calculated?

Over the last 10 years credit scores have been on the rise due to various changes to the model including a settlement with states to not include judgements or tax liens into the credit score.   Many lenders have felt these changes have gone too far and do not appropriately highlight the risk of a consumer default.   As a result, Fico has made 4 major changes to better assess the riskiness of the borrower:

1. Consumers with rising debt levels will see a score reduction
2. Recently missed payments will carry more weight in the FICO score
3. Consumers who sign up for personal loans or payday loans will be deemed riskier resulting in a score reduction
4. More emphasis on utilization, meaning a greater emphasis will be placed on the percentage of your available balance you are using. For example if you have a credit card limit of $5,000 and consistently use $4500 of it your score will be lower than someone who utilizes $1000 of their $5000 balance.

What are the banks doing now to lower your credit?

Banks and financial-technology firms are starting to toughen their approval standards for new loans to consumers and small businesses. That means many people could find it hard to get credit just when they most need it, as the novel coronavirus pandemic puts thousands out of work.

Large U.S. lenders including JPMorgan Chase & Co., Bank of America Corp., Capital One Financial Corp. and Santander Consumer USA Holdings Inc. are among the companies reviewing and revising certain lending criteria, according to people familiar with the matter. Planned moves include approving fewer consumers with lower credit scores, asking for more income documentation and placing lower spending limits on new credit cards.

Furthermore, many lenders also are discussing whether they should lower spending limits on cards that consumers haven’t used in a long time. They worry that consumers will pull out cards they have abandoned in drawers and use them to buy items they otherwise can’t afford.

How does this impact your credit score?

One of the primary drivers of credit scores now is credit utilization.  As banks pull back and lower limits or limit new credit, credit utilization is increased.  Below is an example where a borrower had two cards, but only used one of them.  Assuming the bank canceled the second card that was not utilized, your credit score would be negatively impacted as your utilization just went up substantially.

	amount owed	Card limit
Card 1	5000	7500
Card 2		7500
credit utilization with 2 cards		33%
2nd card canceled utilization		67%

 

Long term impact

The tightening of the economy is on the fast track due to the pandemic.  Lenders are very nervous about the future and therefore taking drastic steps to reduce future exposure.  This trend will continue to accelerate as uncertainty about the virus lingers.

Summary

There is no doubt many credit scores will be lowered due to the new banking standards.  It is a bit ironic that the federal government is spending billions to ensure the functioning of the banking sector while at the same time consumers are having an increasingly difficult time getting loans due to increased underwriting and now lower scores.

Additional Reading/Resources

 

 

1. https://www.wsj.com/articles/fico-changes-could-lower-your-credit-score-11579780800
2. https://www.bloomberg.com/news/articles/2019-10-29/america-s-middle-class-is-getting-hooked-on-debt-with-100-rates?srnd=premium
3. https://www.wsj.com/articles/people-need-loans-as-coronavirus-spreads-lenders-are-making-them-tougher-to-get-11585357440

 

We are still Lending as we fund in Cash!

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.