Credit scores are terribly misunderstood! When I was in my late thirties, I applied for a mortgage and was told that my credit score was 640 and I may not qualify for the best rate – if at all! I was shocked! After all, I had been using credit for many years and I thought it was good. The representative at my credit union politely pointed out that it wasn’t so good. So I went online and pulled my report credit report and score. Lo and behold, my credit score was 690! I went back to the credit union to tell them how wrong they were. That was the beginning of my education on credit reports and scores.
Before the internet credit information and scores were just a big mystery. Probably the biggest misunderstanding is that there is only one score or standard. That is far from the truth. Another is that the FICO is the standard and all the rest are “FAKO” scores. Also far from the truth! I hope to unravel the “mystery” around credit scores, what they really mean and what to do about them.
FICO vs. FAKO – The truth about credit scoring systems
The FICO score was created by Fair Isaacs Corporation and, according to their website launched the first publicly available credit scoring system called, obviously, FICO. Shortly thereafter, Fair Isaacs developed a similar score for Equifax and Equifax named it their Beacon score. Fair Isaacs remains in the credit scoring industry today and have become a public company trading under the symbol FICO.
The first thing to note is that the three major credit bureaus don’t use the FICO score. They each have their own proprietary scoring system – which is similar to the FICO score – but each one uses their own algorithm and range. Experian has many scoring systems but the one they currently sell to consumers through resellers is the ScoreX Plus system. TransUnion also has many scoring systems and their consumer scoring system is called TransRisk. Equifax is similar and their consumer oriented scoring system is now called the Equifax Credit Score although their Beacon score is still commonly used by auto dealers.
And to make things more confusing
Each of these scoring systems have gone through many changes and versions over the years. For example, the same data run through last year’s TransRisk score may not give the same result as this year’s TransRisk score. So, your score could change (slightly) just because the algorithm got updated, but your data remained the same.
And even more confusing
As a result of FACTA the three credit bureaus got together and created the Vantage Score, which is also similar to the FICO score but was developed independently from Fair Isaacs, the creator of the FICO score. Equifax, does, however, have an agreement with Fair Isaacs to sell the FICO score but they make it clear on their website that the two are not the same.
And then there are many third-party scores such as CreditExpert’s score and CE Analytic’s CE score.
Fair Isaacs also develops proprietary scores for other companies such as lending institutions and they update their consumer score on a periodic basis. In fact, there are many versions of the FICO score used by various organizations that are tailored for their purposes.
The scoring systems created and sold by the credit bureaus and third parties have been unfairly dubbed “FAKO scores” implying that the only real score is the FICO score. That is far from the truth. These other scores are every bit as good as the FICO score when used for the same purpose, that is, consumer credit scores. You can’t really compare the special scoring systems built for specific purposes or clients by Fair Isaacs or the credit bureaus.
Consumers are often confused by all this and ask, “Why is the score I pulled different from the score my lender pulled?” Consumers need to understand that the actual number derived from each system isn’t as important as where it falls within the range of the system being used. That is, an excellent FICO score will (usually) also be in the excellent range for the VantageScore as well as the TransRisk score – even though the numbers generated are different. Said another way, consumers should compare the range they fall in when comparing scores and not the actual number.
Facts and fiction about credit Scores – Juicy tidbits you should know!
My score alone determines whether or not I get credit
Mostly fiction. Your credit score represents how “willing” you were (in the past) to meet your financial obligations. It does NOT represent how capable you will be of paying your financial obligations in the future. Although your credit score is certainly taken into consideration, potential lenders also look at additional information such as the amount of debt you can reasonably handle given your income (your debt to income ratio), as well as your employment history, and public records. Lenders will based their decision on all this information – your demonstrated willingness to pay as well as your capability to pay – along with their specific underwriting policies. It is possible that a lender will extend credit to you even though you have a low score or decline your application even though your score is high.
A poor score will haunt me forever
Fiction. Your credit score is based on your credit history at a certain point in time. One month later, it could change and there is no historical tracking of your score (unless you choose to do so yourself through a credit monitoring service). It changes as new information is added to your credit bureau files. Credit scores tend to change slowly as you increase your credit history, make your payments on time, add new credit or cancel existing credit lines. If you have had problems paying your bills in the past and have one or more “delinquencies” on your credit report, they will have less and less affect on your score the older they get (assuming that you don’t cause new delinquencies to be reported). Lenders request a current score when you submit a credit application and never request a “historical” score. So, by continuing to pay your bills on time and being responsible with your credit, over time, you can qualify for more favorable interest rates.
Checking my own credit lowers my score
Fiction. There are, basically, two types of credit checks or “inquiries”. One that is used for the purpose of determining if you qualify for a loan you have applied for and the other that is used to simply check on your credit history. The former is called a “hard-pull” and the latter a “soft-pull”, Hard pulls must be done with your consent (for instance, you are applying for a loan) and these, especially if there are three or more in a short amount of time will have a temporary lowering affect on your score. An exception to this is if you are applying to several different banks for the same automobile loan, then all are treated as one pull. On the other hand, if you request your own report or a lender pulls your file to determine if you they want to make an offer to you, then these soft-pulls will have no affect on your score at all. Advice: if you are about to apply for an important loan such as a mortgage or are waiting on approval of such a loan, it best not to apply for other lines of credit until after you have been approved.
Applying for new credit will negatively affect my score
Fact. Yes, it is likely to lower score – but only temporarily. You might get dinged for the credit inquiry and you are likely to get dinged for adding a new line of credit with no history. I emphasized “with no history” because that is what credit scoring is all about – how much history you have of paying your loans on time. Having ten credit cards for one year is not the same (to scoring systems) as one credit card for ten years. So, if you do need to open a new line of credit, don’t fret. You will soon be developing more credit history the longer you make timely payments.
Is credit scoring Unfair to minorities?
The simple answer is emphatically, no.
All public, consumer oriented scoring systems only consider consumer credit related data. This includes loan information -even for closed or paid off accounts in the last seven years, employment history, last known addresses and (sometimes) public records. Personal information regarding nationality, marital status, gender, race are not recorded at all in your credit file.
By law, the Equal Credit Opportunity Act (ECOA) passed by Congress in 1974 specifically prohibits lending institutions from using this type of information when considering a credit application. In fact, there have been many studies done by independent research firms that confirm these credit scoring systems are completely fair to minorities and people with little credit history. Credit scoring has been shown to be an accurate and consistent measure of a person’s “willingness” to repay their loans for all people who have some credit history.
Free scores and free credit reports and how to get them
In 2003, the federal government passed the Fair and Accurate Credit Transaction Act. In it, the government mandated that the three major credit reporting agencies, Experian, TransUnion and Equifax create a non-commercial website where consumers can get their credit report for free. This site is AnnualCreditReport.com.
At AnnualCreditReport.com a consumer is allowed to pull their credit report from each of the three major credit reporting agencies once per year. For many people this is sufficient – especially if they stagger their reports from each of the bureaus by 3-4 months. In this manner, consumers can check their credit report three times per year without spending a dime.
But AnnualCreditRpeort.com may not be sufficient for everyone and it does come with some caveats consumers should be aware of. One, the FACT Act did not mandate free credit scores. If you want a score, you must still purchase it from one or more of the three credit reporting agencies or from one of many credit reporting sites.” Two, you can’t credit monitoring services from Annualcreditreport.,com. For many people, having their credit file monitored 24/7 365 days a year is important to them since they can be alerted of a potential identity theft in progress as soon as it is reported. Some people just like the comfort of knowing that everything that is reported to their credit file is legitimate as it happens. Finding an error on your credit report three, six, or twelve months later can be a stressful experience.
A few years after the FACT Act was passed, Federal regulators mandated stringent requirements for any credit reporting agency offering “free credit reports”. The most stringent of these was the requirement to disclose the AnnualCreditRepot.com site prominently on their website before offering a free credit report themselves. For this reason, most credit reporting agencies and their re-sellers do not advertise a free credit report. Instead, many offer a free credit score. Some are completely free and some are attached to a free trial of their credit monitoring services and other product offerings.
So, consumers can get a free credit report without obligation, once per year, from each of the credit bureaus at Annualcreditreport.com. And they can get a free score from one of many credit reporting agencies and re-sellers, but there may be conditions attached.
Credit scoring and your privacy
All consumer oriented credit scoring systems consider the exact same information banks and other lending institutions look at; namely, the data in your credit file that is kept by one or more of the three major credit reporting agencies. It does not look at information in your credit application or other information stored only by your bank. A score is simply a numeric summary of your credit file information. So, consumer credit scores don’t reveal anything that lending institutions don’t already have access to.
Privacy advocates, however, aren’t as concerned with credit scores and credit applications as they are with who has access to this information. Some companies, for example, as part of a background check for hiring purposes, will pull your report and/or score – but only with your permission. Same with insurance companies and other institutions. Many believe that legislation should be put in place to limit the access to this information only to lending institutions and only when considering your application for a loan. They feel that it is your financial data and only you should decide who has access to it.
Is your data “safe”? Yes, for the most part. If you are concerned about this, you can place what is called a “Security Freeze” on your credit file. Security freezes prevent, in most cases, Lenders from accessing your credit file without your specific approval. However, this comes with certain drawbacks. A security freeze may delay or prohibit timely approval of an application you make for a new loan (or credit at point of sale), a rental, or even employment. It could also hinder applications for licenses, investment accounts, telephone service or utilities.
Each credit reporting agency has its own process for initiating the freeze as well as releasing the data when needed. You should contact each of them if you do decide this is right for you.
And, remember, lenders with whom you have an existing relationship are generally exempt from security freezes for account reviews, debt collection, fraud prevention or other similar reasons. If you are about to apply for credit, you should try and remove the freeze a few days before actually applying.
So, where do you go from here?
If you haven’t done so already, you should start by getting your Experian ScoreX Plus score along with your credit report. Review your report for accuracy and if you see anything that you don’t recognize or appears to be in error, contact the credit bureau that is reporting it and ask for the issues to be corrected. While you are at it, you should definitely consider signing up for credit monitoring services that keep you informed of any changes to your credit file – which could be an early warning sign of identity theft.
How about you all? What do you find is/are the most common misconceptions about credit scores? How often do you check your credit score?
Share your experiences by commenting below!
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