Sliding economy raises questions about credit scores

— -- Through all the foreclosures, staggering stock market losses and dissolved personal fortunes, one measure of Americans' financial health has remained surprisingly steady during the recession: the consumer credit score, used by banks and lenders to determine how much credit to give borrowers, and at what rates.

But that's finally beginning to change, and the economic turmoil in households is not solely responsible.

Banks and lenders are shoring up risks — closing a record number of credit card accounts and reducing millions of dollars in credit lines. As they clamp down, even some consumers with excellent credit and spotless payment records are seeing their credit scores reduced because of the diminished credit lines. That, in turn, can hamper consumers' ability to get credit elsewhere.

Mary Lou Reid, 61, says two of her credit cards were closed recently because of inactivity, eliminating $47,000 of available credit. Her credit score dropped to 726 from 757. The most widely used credit scores run from 300 (very poor) to 850 (pristine).

"They didn't give me any warning," says Reid, of Arcadia, Calif. "One needs to feel in control of one's life, and what they've done here is cut me out of the equation."

As lenders' appetite for risk wanes, they're pulling back on an unprecedented amount of credit — up to $2 trillion on cards alone by 2010, estimates analyst Meredith Whitney.

"It becomes this self-fulfilling problem," says Mark Zandi, chief economist at Moody's Economy.com. "Lenders cut credit lines, and if consumers simply do what they had been doing, their credit score could fall. Other lenders respond by cutting their own lines or raising rates."

The cycle concerns consumer advocates and some legislators. Some wonder whether restrictions should be imposed on lenders' ability to slash credit limits and close accounts. And if scores can drop even if consumers do nothing wrong, they say, it raises the question of whether there's a flaw in the credit scoring formulas relied upon by the nation's lenders, insurers, and increasingly employers and landlords.

USA TODAY, in previous stories in its "Credit Trap" series, has reported that during the housing boom, banks sharply raised card limits in part because of a surge in home equity, then guided borrowers to use mortgages to pay off card balances.

Now, when it's already difficult to qualify for loans, lenders' actions can lead to deteriorating credit scores that can put much-needed credit out of reach for a growing number of consumers. Those who get loans may have to pay higher interest rates. Lenders also may seize upon lower credit scores to increase interest rates, pushing consumers deeper into distress.

Jobs, and even auto insurance, can be affected if consumers don't have good credit ratings. Most auto insurers now take credit scores into account in determining their rates. And 42% of U.S. employers routinely do credit checks on job applicants, according to the Society for Human Resource Management.

Bank officials say they're aware of growing concerns about the effects credit-line reductions and account closures are having on credit scores. But as the economy worsens, they say, more consumers are struggling, so it's only natural that institutions take steps to reduce risk before borrowers default.