Consumers should not take credit score gains for granted

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Credit Sesame discusses recent credit score gains and why the rising trend may have ended.

FICO recently announced that the US average for its widely-used credit score reached an all-time high earlier in 2023. That’s good news, but it has some strings attached.

There are several reasons to believe that some recent credit score gains may not be sustainable. Consumers with newly-improved scores will need to be vigilant to make sure their scores don’t suffer a relapse.

Most of all, consumers must be aware of several conditions threatening their credit scores. Sustaining a good credit score may mean adjusting credit habits accordingly.

Slow but steady credit score gains

FICO announced that the average US credit score reached a record high of 718 earlier this year. That’s a gain of two points from the previous reading in October 2022, tied for a record high.

Credit scores have been making steady progress since just after the Great Recession, but it’s been a slow climb.

The average credit score bottomed out at 686 in October of 2009. The economy was still in the aftermath of the Great Recession and in the throes of a real estate crisis that saw annual foreclosures rise into the millions. It’s not surprising that credit scores suffered in this environment.

Since then, the rise in the national average credit score has been almost uninterrupted. FICO reports the average credit score twice a year. Since October of 2009, that average has declined on only two occasions.

Still, while credit scores have been rising since 2009, their climb hasn’t been rocket-propelled. The average credit score has grown at just 2.4 points per year. Before rising to 718 in the latest report, the average had plateaued at 716 for four straight observations.

Progress on credit scores has been slow even though consumers have had a lot of conditions in their favor. The years since 2009 have seen a long period of unusually low interest rates, a strengthening job market and an extraordinary amount of pandemic financial assistance for households.

These factors put consumers in a great position to improve their credit scores. However, there are several reasons to believe it will be more challenging from now on.

Pandemic aid programs have ended

To counteract the economic impact of the pandemic, the federal government undertook an extraordinary series of measures, including:

  • Direct financial assistance checks to most households
  • Extra child tax credits
  • Supplemented unemployment benefits
  • Suspended student loan payments

The number of households benefiting from these measures far exceeded those who lost income due to the pandemic. With all this help, it is perhaps unsurprising that people were able to get on top of their debt payments. Now that these assistance programs have run their course, consumers will have to make their debt payments themselves.

Higher balances will make payments tougher

In March of 2021, revolving credit balances (most of which are credit card debt) got down to $911 billion. By August of this year, the figure was up to $1.252 trillion, a 37% increase.

Bigger balances mean bigger minimum payments and longer repayment periods. This puts additional strain on household budgets, making it much tougher to keep up with the bills than just a couple of years ago.

Rising interest rates add to the burden

Not only are debt balances higher, but the interest rates charged on those balances have also risen.

According to the Federal Reserve, in the third quarter of 2023, the average interest rate charged on credit card balances was 22.77%. As recently as the middle of 2020, it was just 15.78%.

That’s almost a 7% increase. That equates to an additional $7 yearly for every $100 credit card debt. When you project that over $1 trillion in credit card debt, it adds up to a huge toll on consumer budgets.

Every dollar you pay in interest is one less dollar of your payments that goes towards paying down your debt. Putting higher interest rates together with higher balances means consumers are shelling out more than ever to keep up with the interest on their debt.

Late payments are rising

The impact of all the factors discussed so far–the end of special pandemic benefits, larger debt balances and higher interest rates–is evident in the growing number of debt payments that are overdue.

According to the September 2023 TransUnion Credit Industry Snapshot, payment delinquency rates are up over the past year for auto loans, credit cards and mortgages.

That means you can add late fees to consumers’ growing debt burden. That’s one more factor that makes it even tougher to keep up with payments in the months ahead.

Removing medical debt is of dubious benefit

Another reason credit score improvements may be short-lived is because some consumers recently benefited from a one-time boost by removing specific types of medical debt from credit reports.

Under pressure from regulators, the three major credit bureaus have decided to remove the following from their credit reports:

  • Medical debt that had been referred to a collections company but has now been paid
  • Medical debt that has been in collections for less than one year
  • Medical debt of less than $500 that is in collections

While there will be ongoing benefits to credit scores from keeping the above off credit reports, the biggest across-the-board bump is likely to be felt from the initial implementation of these policies.

The logic is that people don’t choose to take on medical debt, so they shouldn’t be held responsible for having trouble paying it. That sympathetic view is understandable but may not be practical.

From a lender’s standpoint, the reality is that medical debt isn’t much different from any other kind of debt. It is a financial burden that can hamper a consumer’s ability to pay other bills. Suppose lenders conclude that artificially raising credit scores by not counting specific debt problems doesn’t accurately reflect consumers’ ability to pay. In that case, they may increase the credit scores required to approve certain types of credit.

Sustained credit score improvement will depend on better habits

Ultimately, more credit score gains are unlikely to come from temporary government programs or ignoring certain types of debt. It is more likely to result from consumers cutting back on their debt habits and borrowing less. While overall borrowing slowed, consumers continued to take on revolving debt at a double-digit annual pace.

Payment history and credit utilization are two major factors in calculating credit scores. As debt balances and late payments continue to grow, it seems inevitable that recent gains in credit scores may start to reverse.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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