Improved Credit Scores May Not Last

Government assistance in the pandemic has improved credit scores.

Credit scores range from 300 to 850, with higher scores indicating that a borrower is more likely to make payments on time. Credit score developer Fair Isaac Corporation (FICO) reports that the average credit score in the United States is at an all-time high of 711. The following are averages by age group:

Average 2020 FICO Score by Age Group
– – – – – – – – – – – – – – –

758 75 and older
736 56-74
699 40-55
680 24-39
674 18-23

Since the subprime mortgage crash of 2008, the percentage of borrowers categorized as subprime has steadily declined. Despite the pandemic’s pausing of the economy, the disappearance of subprime-rated borrowers accelerated since March 2020.

An obvious explanation is that people spent less while hunkered down at home, and also received stimulus income from the Treasury. However, another key factor was forbearance provisions (loan forgiveness, temporary in this case) in the Cares Act.

Therefore, according to the April 30 FEDS Notes, “Developments in the Credit Score Distribution over 2020,” the recent migration of many borrowers from subprime status to better risk categories “might not reflect an improvement in the overall credit quality of households.”

The main beneficiaries of forbearance were mortgage and student loan borrowers.

Federally backed mortgage payments were paused penalty-free for a year, and Department of Education student loans went into no-interest forbearance through September 2020. All such loans are reported as “current” despite the missing payments, preventing damage to credit scores.

The FEDS note goes so far as to say forbearance deserves most of the credit for better credit: “Analysis of the credit score distribution, payment history, and other main determinants of credit scores point toward forbearance largely driving the increase in scores.”

Given the temporary nature of this credit score improvement, no wonder “lenders do not appear to have made credit substantially more available to borrowers benefitting from forbearance. Borrowing has remained relatively flat among segments of the distribution that saw their scores rise the most and that are usually very responsive to credit availability, suggesting credit supply did not substantially increase.”

Unfortunately, the note concludes that the credit score increases that began in early 2020 “are likely to unwind once forbearance programs and other stimulus measures lapse, absent considerable job recovery, active household deleveraging, or other interventions to keep borrowers current on payments.”

Conclusion: Improved credit scores may not last.

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