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Blind spot on credit reports is clearing up

Fred Williams

With their files on 200 million consumers, credit bureaus seem to have all-seeing powers, like some financial version of Tolkien’s Eye of Sauron. But they had a tricky blind spot over one aspect of your financial strength — until now.

The big three credit bureaus are adding details about your credit card payments that show whether you are carrying a balance or paying it off, with potentially large implications for your credit profile.

“With the data we had previously, we weren’t able to reliably make that differentiation,” said Antoni Guitart, director of analytical services at TransUnion.

As I wrote about earlier this week, TransUnion and Experian have already added the data to consumers’ credit reports, and Equifax says it will complete the process during the current quarter.

Based on the newly added data, TransUnion announced a study measuring the credit risk connected with the two groups. The study compared cardholders who pay a high multiple of the minimum to cardholders who pay only the minimum, or slightly more. The findings: Minimum payers had a default rate four times higher on mortgages, 11 times higher on car loans and 29 times higher on credit cards.

The result isn’t much of a surprise. What’s surprising is how little insight creditors had into these two groups until now. “I think there’s been an understanding of that (risk difference),” Guitart said, “but we didn’t have the data to quantify it.”

About 60 percent of cardholders pay less than their full balance, and about 20 percent pay only the minimum, TransUnion found.

If you pictured them as rock climbers, the minimum payers would be clinging to a ledge, slowly making their hazardous way upward. Those paying the full balance monthly, on the other hand, are sitting safely on the summit, using their cards to make purchases conveniently while enjoying an extra month to pay the bill, interest free. They’re probably also using rewards cards to rack up airline miles, points or cash back.

Traditional credit scores do not look at the amount of your card payments, only whether you made them on time. The FICO score looks at your “utilization rate,” the percentage of your credit that you are using. It is an important factor in your credit score, but a crude one. Since the rate is based on a snapshot of your balance at one point in time, it can’t tell the difference between a balance of purchases that will be wiped to zero by the due date, or an interest-bearing balance that carries over from month to month.

People who were especially concerned about their credit score — say, if they were in the midst of applying for a home loan — were told to make more than one payment per month. This would lower the utilization rate by reducing the snapshot balance captured on the credit report.

As creditors gain more experience looking at card payment history, it should be easier for transaction-oriented card users to qualify for credit without jumping through extra hoops.

But what about the ledge-clingers? Will they have a harder time winning a loan officer’s approval?

“That is the type of business decision that lenders are going to have to measure carefully, and apply in their own portfolio,” Guitart said. He expects it to take some time for lenders to get familiar with payment history data and see how it links to default risk among their own customers.

“We’re envisioning these metrics as a way of helping lenders and consumers get a better sense of risk,” he added. “When you improve your quantification of risk, I think everybody wins.”

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