The Truth about Credit Card Utilization

[Anonymous]

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@ruhul wrote:

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From what I read in this forum, This bump happens as snap shot. So..This will reflect in the score soon, right?

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What you've read is that credit scores are based on a moment in time snapshot of one's CR.  Your scores will change as your balances update on your accounts, which could be anything from 1 day to 30 days depending on when they last reported.  Do you monitor your reports with any free tools such as WalletHub?  If so, simply watch those accounts and wait until you see the new [lower] balances report.  Once all have reported, that's when you want to go ahead and pull your new scores, as they'll be based on the new, better utilization data.

[Anonymous]

I am a finance guy, MBA graduate, and spent past 25 years working for two of the major banks in the USA. Personally I think people put too much weight on FICO scores. The whole premise of the system is to gauge repayment risk, and assign credit based on that risk. However, there is a fundamental part of the ability to repay missing from the scoring system, and that is liquid assets.

Assume two individuals both with $100k total card limits, (and no late pays) which is the better risk, the guy with 10% Utilization (paying 24% int) and $5k in the bank, or the one with 50% util (paying 0% int with balance transfers) and $250k+ in liquid assets (ie, can pay off balance anytime they like)?

FiCO scores are fairly meaningless when they put so much weight on util vs borrowers ability to repay.

At least put some weighting on how utilization is utilized. For example, should there be a difference in FICO scoring if carry balances at 0% vs paying 24% int? Or if 1 card has 100% util at 0% balance transfer (overall util at 10%) vs carrying 10% in multiple cards paying 24% int with same overall util rate?

Just some musings why there's too much stock put in FICO scores and utilization. As for me, I don't care if my FICO score is 100 pts lower than it should be, I'm gonna continue to use OPM at 0% and invest it for a nice profit (once used $25k 0%balance transfers and turned it into $50k in just a few weeks!).

[909]

To say FICO scores are meaningless is to disregard the fact that they mean a lot to lenders. You'd never say they're meaningless if your score was 690 and you were trying to get the best interest rates on a mortgage (regardless how much liquid cash you had).

You may believe there are better ways to measure risk but your degree and 24 years experience pale in comparison to the army of people who are paid to measure the risks they take when lending money. That army chooses FICO as a fundamental component in its decision making so it means a lot.

[SouthJamaica]

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@Anonymous wrote:
I am a finance guy, MBA graduate, and spent past 25 years working for two of the major banks in the USA. Personally I think people put too much weight on FICO scores. The whole premise of the system is to gauge repayment risk, and assign credit based on that risk. However, there is a fundamental part of the ability to repay missing from the scoring system, and that is liquid assets.

Assume two individuals both with $100k total card limits, (and no late pays) which is the better risk, the guy with 10% Utilization (paying 24% int) and $5k in the bank, or the one with 50% util (paying 0% int with balance transfers) and $250k+ in liquid assets (ie, can pay off balance anytime they like)?

FiCO scores are fairly meaningless when they put so much weight on util vs borrowers ability to repay.

At least put some weighting on how utilization is utilized. For example, should there be a difference in FICO scoring if carry balances at 0% vs paying 24% int? Or if 1 card has 100% util at 0% balance transfer (overall util at 10%) vs carrying 10% in multiple cards paying 24% int with same overall util rate?

Just some musings why there's too much stock put in FICO scores and utilization. As for me, I don't care if my FICO score is 100 pts lower than it should be, I'm gonna continue to use OPM at 0% and invest it for a nice profit (once used $25k 0%balance transfers and turned it into $50k in just a few weeks!).

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One cannot safely invest the money from a balance transfer, and double it within a few weeks. A few decades perhaps but not a few weeks.

[Anonymous]

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@Anonymous wrote:
I am a finance guy, MBA graduate, and spent past 25 years working for two of the major banks in the USA. Personally I think people put too much weight on FICO scores. The whole premise of the system is to gauge repayment risk, and assign credit based on that risk. However, there is a fundamental part of the ability to repay missing from the scoring system, and that is liquid assets.

Assume two individuals both with $100k total card limits, (and no late pays) which is the better risk, the guy with 10% Utilization (paying 24% int) and $5k in the bank, or the one with 50% util (paying 0% int with balance transfers) and $250k+ in liquid assets (ie, can pay off balance anytime they like)?

FiCO scores are fairly meaningless when they put so much weight on util vs borrowers ability to repay.

At least put some weighting on how utilization is utilized. For example, should there be a difference in FICO scoring if carry balances at 0% vs paying 24% int? Or if 1 card has 100% util at 0% balance transfer (overall util at 10%) vs carrying 10% in multiple cards paying 24% int with same overall util rate?

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Ability to repay is very different than actually repaying, though.  There are millionaires and billionaires out there with all of the ability in the world to repay, but they don't.  If someone has the ability to repay "any time they like" due to possessing the liquid assets to do so, then repay it now to prove that you don't just have the ability, but the desire to do so.  In your example above, the guy with little to no assets may actually be a lower risk than the guy with $250k+ in liquid assets if the 10% utilization guy has a greater desire to pay off his debts. 

[Anonymous]

There are plenty of arbitrage opportunities, especially when a stock is fundamentally sound but hampered by the market overall. Bought stocks valued at 25 that dropped to 12 then went back to 25 within a few weeks. The stock was solid but hot by market forces. These opportunities are there if you know how to find them.

[SouthJamaica]

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@Anonymous wrote:
There are plenty of arbitrage opportunities, especially when a stock is fundamentally sound but hampered by the market overall. Bought stocks valued at 25 that dropped to 12 then went back to 25 within a few weeks. The stock was solid but hot by market forces. These opportunities are there if you know how to find them.

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One is as likely to lose money as make money on stock market "opportunities". 

[Anonymous]

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@Anonymous wrote:

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Ability to repay is very different than actually repaying, though.  There are millionaires and billionaires out there with all of the ability in the world to repay, but they don't.  If someone has the ability to repay "any time they like" due to possessing the liquid assets to do so, then repay it now to prove that you don't just have the ability, but the desire to do so.  In your example above, the guy with little to no assets may actually be a lower risk than the guy with $250k+ in liquid assets if the 10% utilization guy has a greater desire to pay off his debts. 

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That first line says it all. For proof, all one has to do is look back to articles around the time of the housing collapse:

Biggest Defaulters on Mortgages Are the Rich

"Strategic defaults—the phenomenon of people who could continue to make payments on the mortgages on their homes deciding to walk away from their obligations—are rising. According to the Wall Street Journal, strategic defaults are likely to exceed 1 million in 2009."

"For a Page One story in today’s New York Times, the paper asked real-estate analytics firm CoreLogic to compile data on delinquent homeowners, and found that one in seven with loans in excess of a million dollars is delinquent."

[Anonymous]

Great references above.  I think it's pretty clear why assets aren't considered by the FICO algorithm.  It's also worth noting that many lenders don't even ask about assets (just income) on applications or for CLI requests, further suggesting that knowing that information isn't relevant in their eyes.

[Anonymous]

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@Anonymous wrote:

Great references above.  I think it's pretty clear why assets aren't considered by the FICO algorithm.  It's also worth noting that many lenders don't even ask about assets (just income) on applications or for CLI requests, further suggesting that knowing that information isn't relevant in their eyes.

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Assets (and indeed income as well) are not considered by FICO because almost all FICO scores (and Vantage, etc.) is based solely on the information on one's credit report.  And the big three credit bureaus do not collect these kinds of data.

As many people are aware, FICO is experimenting with a new scoring model called UltraFICO, which does use asset data (and more specifically the history of a person's checking account) -- and UltraFICO is the exception to the rule I give above.  In order for the consumer to avail himself of that score, he would have to give the scoring entity access to his bank accounts which many people are reluctant to do (wisely in my opinion).  The score is really intended for people who are so credit challenged that they have no loans or credit cards (or perhaps only 1) but who's checking account history might reveal a more encouraging picture of their creditworthiness.

The general points that our friend makes above are sound -- i.e. regarding FICO's historic overemphasis on the current snapshot-in-time of CC utilization.  But the reason was simply that FICO had nothing else to go by except what was in the three bureaus' databases.

A few years ago there was a great deal of hope for a new approach based on something called Trended Data, which the three bureaus only began collecting in 2013 (or thereabouts).  TD allow a scoring algorithm (or a manual reviewer) to see what a consumer's CC balances and payments were month by month stretching back 24 months or more.  The holy grail here would have been for a scoring algorithm to be able to see whether a consumer tended to be a Transactor (paid his CC statement balances in full each month) or a Revolver (paid only a portion and then carried the remainder over to the next month).  Transactors have been shown to be far less risky than revolvers, even when the Transactor has a 50% utilization and the Revolver has a lower one.  TD would have also enabled CC issuers to assess profitability of a customer, which is different from riskiness. 

TD has turned out not to be the great thing that many people hoped it would be, however, because many CC issuers are still not reporting the full spectrum of TD, especially the date and amount of every payment.  But perhaps that will change in the next couple years, in which case FICO might include the Transactor-Revolver distinction in its next model (FICO 10).

BBS makes a good point, which is that lenders and CC issuers have always asked for supplementary data (e.g. income) in order to make their decisions.  No creditor relies solely on the FICO score -- creditors know that a person could be unemployed with no income and no assets and yet have a FICO score in the 800s.  His point is also sound that almost no lenders ask about assets, although they care a lot about income, which must mean that people with big assets are not less likely for default than those with few assets -- a point made by those news stories we saw given above.