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A Boost for Credit Scores

By Kenneth R. Harney
Saturday, August 4, 2007

A major credit card company is ending a long-standing practice that critics have said raised many of its customers' borrowing costs when they applied for mortgages and home-equity loans.

Capital One Financial, based in McLean, said it will start reporting all cardholders' credit limits to the three national credit bureaus -- a step that could boost the FICO credit scores of some of its 50 million card customers within a few months.

Higher FICO scores, in turn, will allow Capital One cardholders to qualify for lower mortgage interest rates when they buy or refinance homes. An increase from 659 to 700 would have cut an applicant's mortgage rate quote last week from 7.68 percent to 6.59 percent on a 30-year fixed-rate mortgage of $300,000, according to Fair Isaac, the developer of the widely used scoring system.

Monthly interest and principal payments would drop from $2,135 with a 659 score to $1,914 with a 700 score. That $221 decrease would save the buyer $2,652 in the first year alone -- and tens of thousands of dollars over the term of the mortgage.

In part because of its huge presence in the credit card market, Capital One has come under intense criticism by consumer and lending industry groups for withholding its customers' credit limits from its regular reports to Equifax, Experian and TransUnion, the three national credit bureaus.

Why all the fuss? Although most consumers are unaware of it, their credit scores can be artificially depressed if creditors do not report their credit limits. That's because Fair Isaac assigns a heavy weight -- 30 percent of a person's score -- to what is known as "utilization" of available credit. Utilization basically boils down to this: If you've got a card with a $5,000 credit limit and you're carrying a $4,750 balance, you've got a 95 percent utilization rate. FICO's scoring system -- which runs from 300 to about 850 -- subtracts points for high ratios. The rationale is that people who are maxing out their cards are perceived as riskier and more likely to fall behind on payments.

On the other hand, say you're carrying a $500 balance on that same card -- a 10 percent utilization rate. The FICO system rewards you with extra points because of your moderate and responsible use of available credit.

When a creditor withholds or neglects to report your limit, the FICO software cannot compute a utilization ratio. Typically, it either doesn't use that credit line to compute the score or substitutes your highest reported balance on the account for your actual limit.

Both options can lead to serious damage to your score. Take the example of the card with a $5,000 credit limit. Say you've never racked up more than $1,000 on the card in any given month. That moderate 20 percent usage should add points to your score. But if your card company never reported the true limit, the system may treat your high balance of $1,000 as a proxy for your limit.

What if you routinely carry a $850 or $950 balance on that card? Now your utilization ratio -- 85 percent to 95 percent -- makes you look like a high-risk heavy user and your credit score takes what could be a precipitous plunge.

Over the years, Capital One has brushed off criticism that it was needlessly harming its customers by withholding their account limits from the credit bureaus. Equally bad, said some consumer groups, Capital One never disclosed the practice to its customers. Although industry critics said Capital One's purpose was to hide its good customers from competitors searching credit-bureau files for attractive FICO scores, the company said it was protecting customers' privacy.

A Capital One spokeswoman, Tatiana Stead, told me last week that the company decided to report credit limits because "like any policy that our customers may have concerns about, we constantly reevaluate our practices." The change, already underway, is expected to be completed by the end of this year, she said.

Lender and consumer group reactions to the policy switch were grudgingly positive. "It's about time they stopped hurting their own customers," said Ginny Ferguson, a credit scoring expert for the National Association of Mortgage Brokers.

Travis B. Plunkett, legislative director of the Consumer Federation of America, welcomed the change but lamented that "so many people were put at a disadvantage by their own credit card company."

Kenneth R. Harney's e-mail address is KenHarney@earthlink.net.

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