Maine Office of Consumer Credit Regulation
As a regulator enforcing Maine's credit reporting laws, I have tried to learn as much as I can about credit scoring. The ingenuity of the scoring models and the complexity of the applied mathematics are very impressive, and I have no doubt that use of such scores permits creditors to make fast decisions on consumers' applications. However, from the consumer's perspective, I harbor great concerns about the exponential growth in the use of such scores, not only for credit decisions but also for seemingly unrelated charges, such as automobile insurance premiums. I can summarize my concerns as follows:
Concern No. 1: Credit scoring has led to a "re-mystification" of the credit reporting system.
In 1969, during the debate on the original Fair Credit Reporting Act (FCRA), Wisconsin Sen. William Proxmire spoke of the congressional intent behind the law:
"The aim of the Fair Credit Reporting Act is to see that the credit reporting system serves the consumer as well as the industry. The consumer has a right to information which is accurate; he has a right to correct inaccurate or misleading information, [and] he has a right to know when inaccurate information is entered into his file. ... The Fair Credit Reporting Act seeks to secure these rights. "
In other words, passage of the FCRA represented an effort to "de-mystify" the credit decision-making process. In the years since passage of the act, consumers, creditors and regulators have become relatively comfortable with the use of traditional credit reports.
However, I fear that the creation and use of credit scoring systems constitutes a step backward from the goals of the Fair Credit Reporting Act to make credit reporting data accessible, understandable and correctable, and to make credit reporting agencies responsive to consumers. In other words, just as the FCRA "de-mystified" the storage and use of credit information, credit scoring is now serving to "re-mystify" that process.
Concern No. 2: A double impact results when an error in the underlying data impacts a credit score.
The fact that a large percentage of credit report data is accurate is of little comfort to a consumer whose report contains harmful errors. If errors in the underlying data result in a low credit score, in effect the original error is compounded.
In addition, the consumer now finds himself twice removed from the actual problems.
A credit-scoring system creates a new layer of data, and that new layer separates the consumer from the raw data. The system as a whole becomes less accountable to consumers. When the Federal Trade Commission decided not to treat credit scores the same as traditional reports, not only did this decision remove the legal responsibility to disclose the score but also to correct an inaccurate score and notify previous recipients at the consumer's request.
Concern No. 3: Because there are so many different products, and because these products are ever-changing, consumers cannot be educated about common rules or standards.
Let's look at the current range of products: Trans Union has Emperica, Experian uses the name Experian/Fair Isacc, and Equifax offers Beacon. In addition, Fannie Mae has developed Desktop Underwriter (DU), while Freddie Mac uses its Loan Prospector. Other lenders use Axion or Pinnacle.
Over the years, those of us who assist consumers with credit report issues have managed to get our arms around the "big three," but it is much more difficult to make sense of the myriad variations on the credit-scoring theme. Even something as simple as score values is very confusing: My files contain the statements of four different experts who describe the range of scores in the basic Fair, Isaac (FICO) model as 300 to 900, 400 to 900, 336 to 843, and 395 to 848. If product offerings are such that the "experts" can't agree on basic information, how can consumers be expected to gain a meaningful understanding of the scoring process and its impact?
Concern No. 4: Reason codes. Everyone gets four, regardless of how good or bad their scores.
Reason codes are four numbers found at the bottom of a credit scoring report. They equate to generic reasons why the given score isn't higher. For example, on one basic FICO
model, Code No. 28 means "Too Many Accounts." Code No. 5 means "Too Many Accounts with Balances." Code No. 4 means "Too Many Bank or National Revolving Accounts."
Four codes are provided whether your score is 400 or 800. For those with great scores, four may be too many. For those with low scores, four may be too few.
Why can't reason codes be specific, as in, "The fact that your 1972 Pinto was repossessed in January results in a reduction of about 40 points from your score." Don't we have the technology to do that?
In addition, some of the factors used to determine scores seem illogical on their face, the most obvious being the effect of closing existing, older, unused credit accounts. From most real-life perspectives, closing such accounts should be a good thing. From a scoring perspective, however, that action harms a score in two ways: First, it increases the ratio of used credit to available credit by reducing the denominator of that fraction. Second, it decreases the average age of a consumer's credit lines, resulting in further score reduction.
As another example, industry sources have told me that a consumer gains points for doing business with established banks but loses points for doing business with small loan companies or check-cashers, even if payment histories are identical. In other words, there is good credit and bad credit, which may have more to do with a consumer's neighborhood and lifestyle than with an accurate prediction of the chances of future repayment.
And consider the advice that consumer advocates have given for years: Compare APRs and shop around for credit to get the best deal. Shopping around these days means piling up inquiries on one's credit report. Despite recent efforts within Fair, Isaac-based models to discount groups of inquiries, the fact remains that numerous inquiries negatively impact credit scores. (In one basic FICO model, Reason Code No. 8 translates to "Number of Recent Inquiries.")
The growing use of credit scores compounds the illogical results. For example, if a consumer pays cash for purchases throughout his or her life, should that result in an increase in a consumer's auto insurance rate? That has been the actual outcome when "thin" files result in low credit scores, which are subsequently (and legally) used by insurers to set insurance policy premiums.
Concern No. 5: Creditors will probably begin to rely too heavily and exclusively on credit scores, despite "instructions" to the contrary.
Creditors are busy, and underwriters are often not rewarded for taking risks. The logical result will be a dependency on credit scores and a reluctance to look to a broader picture. What was introduced as a tool expressly to be used in balanced conjunction with other criteria is quickly becoming a litmus test. To quote Chris Larsen, CEO of online lender E-Loan: "Lenders are increasingly relying on these scores. Many loan products, including some home equity loans and auto loans, are based almost entirely on your FICO score."
Many aspects of the credit scoring process have now gotten ahead of the ability of consumers to make sense of the system and of regulators to meaningfully assist those consumers. Providers of credit scores should be required to share responsibility for ensuring the accuracy of the underlying data, of correcting that data and of disseminating the correct information if requested by the consumer. Despite repeated assertions by the industry that credit scoring is not a mysterious black box, the lack of any uniformity, oversight or accountability makes that analogy too close to the truth.
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