Credit Scoring: A Flawed System
By Mary Hunt
Founder and Editor of Debt-Proof Living
No one asked you if you wanted one. No one told you when you got one. Even then they don’t tell you what yours is. No, you have to ask—and pay—to look at your credit score. Yet that three-digit number plays a serious role in your finances, your career—indeed, your life.
Fair Isaac Corporation was founded in 1956 by Bill Fair and Earl Isaac, who developed computer systems and software that predict outcome. The company developed and still tightly controls the technology that weighs different factors found in a person’s credit report. The result is a three-digit number ranging from 150 to 934, also known as a FICO score, that grades risk and tells a lender the statistical chances of getting repaid.
Fair Isaac licenses its highly secret technology to credit reporting agencies (CRAs). The CRAs then use that software and add their own programs and statistical data to produce customized credit scores under names like Beacon, Empirica, and Scorecard.
The more I learn about this matter of credit scoring the more I see that it is a flawed system. Credit scoring is not necessary, it is unfair, and it represents a conflict of interest.
There’s no question that a computer can point out a person’s potential for future trouble. But so can a human who reviews a credit report. It should not take software to see if someone has the potential to go bad. Lenders are relying too heavily on scoring factors alone.
Computers don’t care about special circumstances. Everything is either black or white. There is no consideration of a person’s basic character or allowance for the fact that people can change their lives and their behaviors. A computer looks at data and assigns a number. Negatives stay on your credit report for seven years or longer. Murderers have been known to walk out of prison on appeal or probation in less time than it takes to clear one’s credit history.
It’s a conflict of interest
Fair Isaac sells its products and services to companies that issue personal lines of credit. On its Web site it boasts that it influences more than 13 billion credit decisions each year and has sold more than 10 billion FICO scores since 1985. To achieve a high credit score, Fair Isaac has programmed its scoring model to require multiple open lines of credit. It creates the problem for consumers (not enough credit), charges them a fee to diagnose it (credit score), and then prescribes a remedy (get more credit), which sends that consumer to the very industry that creates Fair Isaac’s income stream.
Jeffrey Strain of www.TheStreet.com says that a low credit score could cost individual consumers $1 million in their lifetimes.
Mortgage. According to www.MyFico.com, someone with a good credit score between 760 and 850 can get a mortgage at 6.346 percent APR. But a person with a low score between 500 and 579 will pay 10.152 percent APR. Over the 30 years of the loan, the difference would be $288,000.
Auto loans. Good credit score? You can expect to pay around 7.2 percent APR at this time. But if you have a low score, expect that amount to be nearly double at 14.9 percent APR.
Credit cards. A poor credit score can translate to a credit-card interest rate close to 20 percent, or more.
Insurance. Now that insurance companies have jumped onto the credit score bandwagon, they have adopted their own similar type of scoring based on a person’s credit report. Low score? Expect to get socked with higher premiums —much higher.
Housing. Even landlords are now requiring credit checks as part of the application process for renting an apartment or other real estate. A low score can result in a hefty increase in the deposits required.
What can we do?
We may not be able to eliminate credit scoring as a system, but we can demand change.
First there needs to be an appeal process—both with FICO and every institution and company that uses its scoring model. Customers should be able to meet with a human being who has skills to assess both the assets and the character of the customer.
Finally, credit scores should be available for free, just like credit reports. We have every right to know our scores. They are built using the information about us that is contained in our credit bureau files. A once-a-year, fee-free peek, plus another every time we are evaluated by a business, is not too much to ask.
Mary Hunt is the founder and editor of Debt-Proof Living newsletter, the new finance columnist at Guideposts magazine, an AOL Money Coach and a contributing editor of Woman’s Day magazine. She is the author of 16 bestselling books, and her syndicated Everyday Cheapskate column can be found online and in newspapers nationwide. .
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