How credit scores are used to evaluate credit card applications

By: John Ulzheimer
Date: June 25, 2020
Filed Under:
Use of Credit Scores

In last month’s issue of The Score, we explored how credit card issuers use credit scores when prospecting for new customers. This month, we’re going to pick up where we left off and explore how carrd issuers use credit scores after you fill out those preapproved credit card offers and send them back in.

Let’s suppose you’ve received a preapproved credit card offer that meets your needs, and you’ve fill out the enclosed application and credit card agreement and send it back in to the credit card issuer. What you have just done is to formally apply for credit. By doing so, you have given the credit card issuer what’s referred to as permissible purpose. That’s a phrase, taken from the Fair Credit Reporting Act, that spells out specific circumstances under which credit reporting agencies, including the three major credit reporting companies (CRCs) – Equifax, Experian, and TransUnion – can share your credit report with external parties, such as card issuers and other lenders.

Having received your application, the card issuer first pulls what’s known as a back-end credit report, a designation that simply refers to the fact that it’s requested at the “back end” of the credit card prospecting process. When the lender pulls this report, it will likely do so from only one of the three CRCs. It’s very likely the issuer will also request your credit score from the same CRC. This data will be used to underwrite the account.

The issuer will first use the combination of credit report and credit score to determine whether to approve or deny your application. If your credit situation has changed materially since they mailed the preapproved application, they can, and very well may, turn down your application. (If this occurs, you’ll receive a letter explaining the reasons for the denial; if a credit score was part of the decision, you’ll be told that score.) However, in most cases your score is likely similar enough that your application will be approved and a new card will be issued.

Following the approve/deny decision, the card issuer uses your credit score to help set the terms of your account. Your interest rate and your credit limit are directly influenced by your credit score. If your score is good, you’ll likely get the issuer’s most attractive terms – its lowest interest rate, generous borrowing limit, and so on. If your score is good enough to get approved but not good enough for the best terms, you will be assigned a higher interest rate, and your credit limit will likely be lower. Adjusting interest rates and credit limits allow card issuers to offset the risk of doing business with customers whose credit is less than stellar. This practice, called risk-based pricing, allows lenders to charge higher rates to groups of customers who, collectively, are likely to be more costly over time, in terms of missed payments, defaults, and potential losses to write-offs.

If you receive less-than-best terms upon approval, the card issuer will send you a notification explaining the terms, which you should read very carefully. If a credit score helped determine the terms, that score will be included in the notification. Make on-time payments for a few years, and avoid using high percentages of your credit limit (VantageScore Solutions recommends keeping usage below 30 percent of total limit), and you can expect your credit score to improve. At that point, you may consider contacting the card issuer to see if you can negotiate a lower rate or higher limit.

Next month in The Score, we’ll explore how card issuers use your credit scores for ongoing accounting management.