Long after the economy recovers, millions of Americans will be left with a grim legacy of the recession: damaged credit scores, the three-digit ratings that help determine consumers' ability to get loans and other types of credit.
Even though some consumers have seen their credit scores improve as they trim their debt, others have seen their scores drop significantly because of late payments on bills, foreclosures and rising credit card debt.
Meanwhile, lenders' actions during the recession are delivering another blow to borrowers — even some with pristine credit. Lenders are closing credit card accounts and lowering credit limits for millions of consumers and business owners who have never paid late. Some lenders are reporting mortgage modifications in a way that dings consumers' scores, dealing a setback to those trying to get their finances on track.
More lenders also are adopting a new scoring model the financial industry believes is better at predicting risk — but that could move consumers' scores more than 20 points up or down. The most widely used credit score, the FICO score, ranges from 300 (poor) to 850 (excellent). Consumers with scores above 750 generally qualify for the lowest-rate loans.
"The credit environment has a whole lot of moving parts that weren't there three years ago," says John Ulzheimer, president of consumer education for Credit.com. "Consumers can't just sit still and expect all is well."
From the third quarter of 2006 to the second quarter of 2009, the number of consumers considered "deep subprime" — with such low credit scores they qualify for credit only at steep interest rates, if at all — rose from 34.4 million to 39.8 million, according to research by the Experian credit bureau and Oliver Wyman, a consulting firm.
Meanwhile, the percentage of "superprime" consumers, who are able to qualify for the best rates, dipped in recent quarters, partly because more people paid their bills late, the firms found.
Lenders say they're taking steps to reduce their risk in a difficult economy. Some admit they're concerned about the impact of their actions on consumers' credit scores but say they have no control over how scores are determined.
"Banks have no motivation to take an action that will impair someone's ability to obtain credit," says Claudia Callaway, partner at Katten Muchin Rosenman, a law firm that represents lenders.
But consumer advocates say regulators and Congress need to address lender actions that are unintentionally hurting credit scores. They say that as underwriting standards tighten, even a small change in a credit score could affect what rate consumers get on a loan — if they get one at all. Some analysts also say the fact that consumers' credit scores can fall even if they've never missed a payment or exceeded their credit limits raises questions about the score's usefulness.
"All these changes are new structural changes in the financial system," says Leonard Bennett, a Newport News, Va., lawyer who has testified before Congress about credit-reporting issues. "The ability to predict risk and integrate that into a credit score — based on historic data — is logically impossible."
But Tom Quinn, a vice president at Fair Isaac, which created the FICO credit score, says its data show the scoring formula "is working," because it's able to rank consumers' riskiness.