Fred Clark on FICO scores

Fred Clark writes about why credit scoring should be more of a political issue:

Lenders and debt merchants are in the same boat as the rest of us. They don’t have access to the extra-constitutional triumvirate’s top-secret proprietary information either. But credit-card banks and mortgage brokers and insurance companies and auto lenders have more time, resources and incentive than consumers do for probing the mysteries of these all-important formulae. They’ve pieced together enough of the puzzle that they’ve gotten quite skilled at manipulating this statistical game to their advantage.

Rugaber notes, for example, that “credit card issuers … have recently cut limits on many cards as financial institutions seek to reduce their credit risks.” Limiting risk is one explanation for this step. An additional explanation is that this step alters borrowers’ “utilization rate,” and the cabalistic scholars of credit scoring at these institutions have determined that higher utilization rates make for lower credit scores, thus providing a quantitative fig-leaf for aggressive increases in fees and interest rates.

Here’s how the scam works. You’ve got a $10,000 limit on a credit card and you’re carrying $2,500 due to a recent dental procedure. The lender, in the name of reducing risk, abruptly reduces the limit on your card to $4,000, announcing this change on page seven of the nano-type in a booklet mailed with your next monthly bill. Now instead of a 25-percent utilization rate, you’ve got a 63-percent utilization rate (they round up, when convenient), lowering your credit score.

That lower credit score means you no longer “qualify” for your previous rate of 9.9 percent and will now be paying 19.1 percent. Oh, and there’s a one-time fee of $35 dollars, conveniently added to your existing balance, for exceeding 50 percent of your available limit.

Update: Oh, and if you’re paying only the minimums on your credit cards, you need to change that.