Tuesday, August 26, 2008

Thinking About Becoming an Authorized User? Know What You're Getting Into

Late last month, when Fair Isaac announced that it would not scrap authorized users from its formula when it rolls out FICO 08, many consumers breathed a sigh of relief.

For the uninitiated, an authorized user is someone who is authorized to use another person's credit card for purchases. The credit card company issues a card in the name of the authorized user, but the authorized user is not legally obligated to pay for any charges incurred on the account (except that American Express has some language in its card agreement (story link here) that makes me think some authorized users could be on the hook as well). Instead, the primary cardholder is on the hook for any and all charges. If the authorized user makes purchases, but fails to pay, the primary cardholder must pony up the money.

For years, consumers have benefited from authorized-user status. Authorized users benefit when creditors submit account information to the credit bureaus because the good payment history and credit limits of the primary cardholder inure to the authorized user's credit report. If the primary cardholder has a $50,000 limit on his or her Chase card, for example, that information will appear on the credit report of the authorized user. If that Chase card has always been paid on time, that excellent payment history will be reflected on the authorized user's card history as well. If that Chase card has a lengthy history, that information will be transmitted, too. In sum, authorized users, who hitch their wagon to a responsible primary cardholder, will benefit when the card company reports the authorized-user information to the credit bureaus. (By the way, not every credit-card company reports authorized-user information to the credit bureaus. If you're thinking about becoming an authorized user, you should check with the creditor ahead of time to make sure they'll report the account.)

To be sure, there is also a potential downside when it comes to being an authorized user. If the primary cardholder misses a payment, that information will get reported on the authorized-user's credit report as well. If the primary cardholder maxes out the credit card, that heavy utilization will be reflected on the authorized user's credit report, too. In other words, the bad behavior of the primary cardholder can have a negative impact on the authorized user's FICO score. That's why you never want to be an authorized user on an account that is routinely maxed out or has a spotty payment history.

What's more, if the account is brand new -- opened by the primary cardholder recently -- you'll also get dinged if the age of the new card drags down the overall age of your own credit history. As you can see, being an authorized user is not without its potential pitfalls. So be smart when it comes to being an authorized user. Ditto for primary cardholders. Don't allow someone who is irresponsible to be an authorized user on your account. If the authorized user runs up a huge balance, you'll be on the hook for those charges.

Realizing the potential upside to being an authorized user, it's not surprising that people abused the system. Instead of spouses, the natural beneficiary of the authorized-user system, showing up as authorized users on primary accounts, people started renting accounts to complete strangers -- people who were totally unrelated to the primary cardholder. People who had bad credit could "rent" accounts from people who had awesome credit histories. Indeed, if you could find someone with an old credit card, who had a spotless credit history, and a high credit limit, you could get a score benefit if you could get yourself named as an authorized user on that person's account.

Quick to make a buck, credit-repair companies popped up all over the place, peddling "seasoned" tradelines that could be "rented" by people looking for a score bump. The practice made people look more creditworthy than they actually were, which made it more difficult for lenders to assess the credit risk of these authorized users.

By June of last year, Fair Isaac, the creator of the FICO score, had seen enough. Intent on rooting out the abusive practice of so-called "piggybacking," Fair Isaac said that authorized-user information (of all kinds) would not be included in its new FICO 08 scoring model (link here). The trouble, of course, is that legitimate authorized users in the United States, which Fair Isaac estimates at more than 50 million, would be harmed in the process.

Fast forward to last month, when Fair Isaac reversed its decision to exclude authorized users from its scoring model. In a press release, Fair Isaac said that its scientists figured out a way to include legitimate authorized users while weeding out those trying to game the system. The company wasn't terribly specific on how it would accomplish its goal, saying only that it has created a technology "that will reduce any impact on the FICO 08 score from intentional tampering, while allowing the scores of spouses and other genuine authorized users to benefit from their shared credit experience." Fair Isaac's assurances notwithstanding, it will be interesting to see how Fair Isaac's FICO 08 handles spouses with different last names. Or how it handles children who no longer live at home -- who've changed their last name because of a marriage. Let's just say that I'm taking a wait-and-see approach to Fair Isaac's latest tweak.

Meanwhile, Fair Isaac said the decision to include authorized users in its model would help lenders comply with the Equal Credit Opportunity Act of 1974. Under the Equal Credit Opportunity Act, lenders are legally required to consider accounts that both spouses are permitted to use. See 12 C.F.R. §202.6(b)(6)(i). If Fair Isaac had eliminated authorized users from its FICO 08 scoring model, it would have been difficult for lenders -- relying on the new scoring model -- to comply with the Act. As a result, Fair Isaac had no choice but to find a solution. If it didn't, then it risked losing business.

Meanwhile, VantageScore, a scoring model developed by TransUnion, Experian, and Equifax, has never included authorized users in its scoring formula. I imagine that if the VantageScore ever becomes widely used -- at this point it's a bit player at best -- it, too, will be forced to reconsider how it treats authorized users in the scoring formula.

Now that you understand how the system works, you can make an intelligent decision on the authorized-user question. Should you become an authorized user on your wife's account? What would the utilization on her account do to your score? Is her credit card maxed out? Is it lightly used? Is it a new account -- just recently acquired? Would her new account reduce the average age of your credit history? Does the account have a history of late payments? Is the authorized user responsible enough to not run up huge bills that can't be paid?

These are just some of the questions you'll need to think about if you're contemplating an authorized-user relationship.


Don Miguel said...

It looks like you are thinking along the same vein as I am, that at least part of their alleged scientific mojo that will allow them to distinguish AUs that are gaming involves last names and/or addresses. Possibly, however, they could be counting the number of AUs associated with a given account: if there are N > n (where N is the number of distinct authorized users associated with a given consumer and n is a threshold--constant or otherwise) then the associated AU accounts are either descored or flagged for further review. Someone selling their own AU accounts would likely stand out, though there would be the hazard of false positives associated with particularly fecund individuals who make their children AUs. People who sell one AU account through a credit repair broker are going to be hard to detect that way without a method that relies on surname, though. Another possibility is that they have some solid data on aspects of credit files of traditional authorized users relative to their authorizers--for example, often Mom or Dad with a 700+ score and 20 years of history make Junior or Daughter (based on date of birth or other data to which the CRA might have access) an AU--Junior/Daughter would be expected to have a thin file at the time of having been made an AU. While I'm being fuzzy here, all this can be quantified and searched. And remember that the laws against using age, ethincity, and gender easily inferred from a credit file likely (I'm not a laywer hence the qualifying word) only apply to decisioning, not to "fraud detection" or whatever they might call this process.

Credit Matters said...

DM, I hear you. It would be interesting to see how they actually ferret this stuff out!

Thanks for commenting on the blog. You've always got great things to say.

Hope to see you again.

Jay said...

Hey CM. Thanks for this link. So much to learn. I'm only glad I'm learning it at a younger age then most.

I have a few clarification questions regarding this topic.

1. Does the entire credit history of the card get transferred to the credit report or does it just start reporting from this point forward?

2. If you are removed or remove yourself as an authorized user does that stop reporting as if it was a closed credit card or does it disappear entirely?

GlobCredit.com said...

Jay, the entire history moves to your credit report.

If you remove her card from your report, the history will stop reporting -- and will be deleted. It will disappear entirely.

Jay said...

CM, Thanks Again. It's nice to have so much information and quick responses in one place. I've spent a week or so just browsing so many different resources. Glad I eventually came across your website.

GlobCredit.com said...

Jay, glad you found the site as well. It's gratifying to help people out. Enjoy the site.

If you have any questions, don't hesitate.

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