A major credit-card company is ending a long-standing, controversial practice that critics say raised many of its customers' borrowing costs when they applied for home mortgages and equity loans.
Capital One Financial Corp., based in McLean, Va., says it will now report 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 by 40 to 80 points or more 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 of just 41 FICO points - from 659 to 700 - would 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 Corp., 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 homebuyer $2,652 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 card market, Capital One has come under intense criticism by consumer and lending industry groups for withholding its customers' credit limits in its regular reports to Equifax, Experian and TransUnion, the three national credit data bureaus.
Why all the fuss? Though most consumers are unaware of it, their credit scores can be artificially depressed if creditors do not report their maximum credit limits. That's because Fair Isaac assigns a heavy weight - 30 percent of a person's entire 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, living close to the financial edge, 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 your available credit.
When a creditor withholds or neglects to report your limit, the FICO software cannot compute a utilization ratio. Typically it either omits consideration of utilization of that credit trade line from score computation, 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 the $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 your true $5,000 limit, the system may treat your high balance of $1,000 as a proxy for your actual 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 millions of its customers by withholding their account limits from the credit bureaus. Equally bad, said some consumer groups, Capital One never disclosed this practice to its customers. Though industry critics said Capital One's purpose was to hide its good customers from the prying eyes of competitors searching credit bureau files for attractive FICO scores, the company insisted that it sought instead to protect customers' privacy.
A Capital One spokeswoman, Tatiana Stead, told me July 27 that the company made the decision to report credit limits because "like any policy that our customers may have concerns about, we constantly re-evaluate our practices." The change is under way and expected to be completed by the end of this year, she added.
Lending 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. "They've known all along that [their policy] depressed FICO scores."
Travis Plunkett, legislative director for the Consumer Federation of America, welcomed the change but lamented the fact that "so many people were put at a disadvantage by their own credit-card company."