Why are Americans’ Credit Scores Falling?

In an effort to address arbitrary interest rate increases and excessive fees, President Obama signed the Credit Card Accountability Responsibility and Disclosure Act of 2009 into law on May 22 of this year.   While many provisions are scheduled to take effect in February 2010, some items have already begun. For instance, since August, banks are required to ensure consumers receive statements 21 days before payment is due.  Furthermore, card issuers are now required to provide consumers with a least 45 days notice of any interest rate changes.  However, it is the second phase beginning in 2010 that may have sent many credit card companies scrambling.

While there are many changes that will go into effect during the second phase, it is perhaps the ones geared towards interest rates that have most lenders concerned. Beginning in February, card issuers can only raise interest rates on existing balances if consumers are more than 60 days past due, a promotional rate has expired or the individual’s interest rate is based on a variable index. Such changes pose challenges for credit card companies to maintain profitability. Many credit card issuers have begun phasing out fixed interest rates, or simply outright raising rates to all consumers.  Furthermore, creditors are reducing exposure to risk by lowering credit limits.  But the question on everyone’s mind is, “Are these changes because of the Act, or the economy itself?”

A large segment of customers who were once quite profitable for credit card lenders have simply evaporated. Also, due to the dramatic increase in credit card defaults, lenders are averting risk by no longer offering subprime credit cards.  Knowing full well their business model is going to go through another dramatic change in February 2010, many believe lenders are trying to generate as much income as possible beforehand. While many credit card companies have vehemently stated the changes are a result of the economy, lawmakers feel otherwise.  This has prompted lawmakers to consider enacting the second phase of the Act well before 2010; however, banks have pushed back stating adjustments to the timeframe would not allow enough time to adapt current infrastructure.  Essentially, banking institutions need to update a significant amount of   computer systems in order to handle the changes that will go into place.  Regardless, if things continue on the current path of preemptively changing lending terms, more consumers will feel the effects in their credit score.

One of the more prominent factors of an individual’s credit score is how much credit someone is utilizing versus how much is available to them. Many experts agree that individuals should use no more than 30% of his or her available credit limit at any time. Unfortunately, when credit card companies arbitrarily change credit limits, it places cardholders in jeopardy of breaching this threshold. While using more than 30% of your available credit may cause a slight dip in your credit score, going further beyond that mark can have a substantial impact. When outstanding balances exceed 50% of credit limits, credit scores drop dramatically.  Should the change in limits completely exhaust available credit, an individual’s credit scores could decrease by as much as 150 points.  While it’s difficult to substantiate such a dramatic decrease in credit scores because of the secrecy surrounding the FICO scoring model, it’s not unreasonable to believe such an assertion.

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