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What do lenders think when your credit scores go up and down?

By Sarah Davies
SVP, VantageScore Solutions

recent national study by Experian and Edelman revealed that consumers are concerned about their credit scores and how those numbers impact their ability to obtain loans for major financial milestones, such as buying a home. The survey found that more than a third of future buyers believe their credit scores may hurt their ability to buy a home, and that 45 percent of respondents have delayed certain purchases to improve their credit scores. Nearly all respondents said they are taking steps to proactively change their credit behavior and improve their overall scores.

We’ve entered into an era in which virtually everyone has free access to credit scores —and the ability to track their fluctuations. This is a break from the past, when consumers only saw their scores after applying for loans. Where they once viewed credit scores as snapshots in time, consumers now see them as frames in a movie, potentially rising or falling monthly, weekly, or even daily, depending on the update frequency of their free-score providers. It’s understandable that a consumer, as confident as he or she may be about paying bills on time and managing credit wisely, could be alarmed when a score ticks downward. But before hitting the panic button, it is important to understand these fluctuations, and how lenders might consider them.

We at VantageScore Solutions examined this issue in a recent white paper and found that, yes, credit scores fluctuate often. Any downward shift in credit score can be cause for concern, but all fluctuations are not created equal, and consumers can reverse many of them quickly readily by modifying their behavior.

Using the VantageScore 3.0 model, which has a score range of 300 to 850, the study analyzed the credit scores of two million consumers over a two-year period from 2011 to 2013. The files were selected randomly from the Experian credit-file database and stripped of all personal information.

Within that two-year period, the study examined the ways in which credit scores fluctuated over three-month timespans and 12-month timespans. It found that over a three-month span, for example, 49 percent of the consumers experienced an average credit-score improvement of 19 points, while 30 percent of consumers experienced average score decreases of 24 points. Over a 12-month span, 51 percent of consumers in the study had credit score increases averaging 27 points, while 38 percent had their scores decline by an average of 34 points.

So what’s responsible for these score fluctuations? At the end of the day, they’re all related to your credit-management behavior, as recorded in the credit files maintained by each of the three national credit reporting companies (Equifax, Experian and TransUnion). Your credit files reflect all of your account payments, including whether the payments were made on-time or late; your credit limits and outstanding balances; and the total number of open accounts you have and how long you’ve had them. Your credit files may also indicate if you have experienced personal bankruptcy, financial judgments, tax liens, or other negative events.

Model developers use advanced statistical analysis to identify behaviors (and combinations of behaviors) that indicate your risk of default (which is defined as becoming delinquent for 90 days or more). Behaviors that indicate greater risk can cause scores to decline, but credit scoring models recognize that not all risk-related behaviors are equally detrimental. Those deemed relatively insignificant result in small score shifts, which are short-lived, while those that are viewed as being more serious result in large shifts that are longer lasting.

When managing personal credit, it’s important for consumers to manage the score-lowering behaviors that are are quickly reversible, and to avoid events that have longer lasting impact. For instance, changes in credit-usage levels (the percentage of available credit a consumer uses), are relatively easy for a consumer to control: Using a high percentage of available credit, or even “maxing out” credit cards, can cause significant declines in credit scores, but scores will rebound quickly as those cards are paid down and usage levels are reduced. (VantageScore Solutions recommends keeping usage levels at or below 30% of the available limit.)

In contrast, events that become part of your credit history—such as late payments, or debts that are sent to collection agencies—remain in credit files for years. Their negative credit score impact diminishes over time, but much more slowly than the dips caused by occasional (and temporary) use of high percentages of available credit.

Impact on score-based decisions

The VantageScore study looked at the effects that the fluctuations in credit scores would have with respect to a typical “score cut-off” – a score value that lenders might use as a threshold for accepting loan applications. Using a cut-off of 620, VantageScore found that 6.4 percent of the total population would have received the opposite decision if their score had been reviewed three months later.

That means that some consumers who are turned down for loans today might have better luck in a few months’ time—and it also means some borrowers who squeaked by a few months ago might not be eligible for a loan today. Individuals who fall in either camp would do well to be vigilant about their credit habits, for example, by taking care to make payments on time and to avoid running up high account balances.

Such vigilance makes sense because lenders do more than just check your credit score, or act upon it, at the time when you apply for credit. Lenders, particularly credit card issuers, generally monitor their customers closely and regularly. They rely on many types of data, including credit scores, for such monitoring. Lenders ultimately base credit scoring-related decisions on whether a single score threshold is met at a given moment in time. But which score threshold applies to a particular consumer, and which actions are taken when that threshold is crossed, can depend on tendencies over time, including credit score trends.

What constitutes a “major” credit score fluctuation is in the eye of the beholder, but for VantageScore 3.0, a useful threshold is plus or minus 40 points. If a consumer’s credit score drops by 40 points, that indicates that the odds of that consumer defaulting have doubled. If, on the other hand, a consumer’s credit score increases by 40 points that indicates that the odds that the consumer will default have decreased by half.

Declines of fewer than 40 points are often the result of day-to-day credit management actions, which do not necessarily reflect a substantial increase in risk exposure to a lender. In other words, consumer activities like authorizing credit inquiries (when applying for credit, for example), opening new accounts, or temporarily increasing usage of available credit limit, might cause short-term score drops, but such activities are not necessarily the red flags that would cause a lender to reduce a credit line or take some other sort of mitigating action.

By contrast, larger, longer- lasting declines in credit score typically occur when a consumer pays bills 30 or 60 days late, or when more catastrophic events such as bankruptcy or a legal judgment appear on a credit report. These credit behaviors have a greater impact because testing has shown that consumers who act in this manner are more prone to default. A lender is much more likely to take mitigating action in such cases.

This is how lenders might deal with score fluctuations, but what is the lesson for a consumer?

Score fluctuations of 40 points or less are fairly common and, as the saying goes, slow and steady wins the race. There is no need to panic about small score fluctuation as long as you continue to practice good credit behaviors, like paying bills on time. If you see a larger decline in your score and you know you have been managing your credit appropriately, check your credit reports to make sure that there are no errors or other information that might indicate that you have been a victim of identity theft.

For more information, go to www.yourvantagescore.com.

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