Heads or Tails?

A few months back, I blogged about the fact that, increasingly, we’re seeing borrowers whose credit scores are getting hammered because of factors largely outside their control. I proposed that lenders delve deeper into the details of applicants’ credit histories to determine the root of the lower credit scores.

“If not, lenders will pass up some great borrowers who simply hit on hard times,” I wrote at the time. “And borrowers will have to wait longer to secure credit, which will significantly slow the industry’s rebound.”

(To read the original post and the back-and-forth that ensued, click here.)

But here’s the flip side of that coin, as pointed out to me yesterday by the chief credit officer at a small nonprime finance company. Lenders actually need to perform the opposite analysis on their portfolios: Are credit scores being artificially inflated because of credit inactivity? In other words, nowadays you might find more customers whose average revolving balances are down — because they had their credit card limits capped — and their number of credit inquiries is lower — because credit is tight. Their credit scores might end up 30 points higher, but is that an indicator that they’re paying better than before? Not necessarily.

The bottom line, as the credit chief officer put it: Scorecards predict yesterday perfectly.

Once loans are on the books, all that lenders can do is manage them to the best of their ability. Be aware of potentially inflated credit scores, just as you are cognizant of potentially deflated scores. And if something is amiss, accelerate the collection process.