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The credit score industry, today
Giving yourself a credit check
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TEXT OF INTERVIEW
Kai Ryssdal: To the list of things given a thrashing by the Great Recession and financial crisis of the past two years or so -- that would be employment, consumer confidence, real estate and the stock markets -- you can now add personal credit scores. FICO, the company that helped create the credit score industry, said today that 25 percent of us now have scores below 600. That's a sizeable bump from pre-recession days. It means more of us will have trouble getting affordable credit.
Joan Goldwasser writes for Kiplinger's Personal Finance Magazine. Good to have you here.
Joan Goldwasser: Nice to be with you.
Ryssdal: Is it surprising to you that a quarter of the people out there have credit scores below 600?
Goldwasser: Not terribly surprising. I mean, we know that people's credit scores have been dropping. If you foreclosed on your home, that does terrible things to your credit score. It drops it about 150 points. If you stop paying your credit cards, because you just can't afford to, that also will do really bad things to your credit score.
Ryssdal: Play it out for me a little bit in terms of the entire economy. The economic recovery is dependent on people getting out and spending more and consumers being more active, yet if they can't get those loans, they can't do that, so the economic recovery sort of doesn't really get going anywhere.
Goldwasser: That's right, I mean consumer spending accounts for about two-thirds of our economy. So people will be buying the necessities of life, but they wont be buying new cars. They're not going to be buying houses. People are paying down debts, which is good for their personal balance sheets, but as you said, it's not great for the economy.
Ryssdal: Speaking of people paying down their debts, there's also been a jump in people whose credit scores are over 800. That is the people who can are paying off their debts, paying off their credit so their scores are going up.
Goldwasser: That's what they call the "super prime" category. And those people will actually see credit card offers in the mail, and they will be for rewards cards and low balance or zero percent balance transfer offers. They're people that everybody wants to have in their folios.
Ryssdal: Yeah, people who probably don't need more credit right?
Goldwasser: Probably not.
Ryssdal: Alright from super-prime then to sub-prime, I guess, there's been a jump in the number of people with credit scores nearing 300. Pretty much the bottom of the barrel. How do you survive in such a credit-oriented economy when you can't get credit?
Goldwasser: You probably don't have a credit card. But if you need to borrow money, if your car needs to be repaired or you get sick, you're really in bad shape and you may be forced to go to a payday lender or somebody that's going to charge you a usurious rate of interest.
Ryssdal: Which will do eventually nothing for your credit score, right?
Goldwasser: Oh no. You'll probably just get deeper in debt.
Ryssdal: We've had this amazing credit event the past two and half, three years in this economy. Credit scores are completely out of wack. Might lenders now say well you know, 600 is OK; 550, we can do that -- and they won't be looking for the 750, 800 credit score people anymore?
Goldwasser: We haven't seen any evidence of that. What we've been seeing is really the opposite. People who have credit cards have seen their interest rates go up. We've seen the credit lines cut back. I mean, we've seen banks try to get their own balance sheets in better shape and I don't know whether they're going to start to be more lenient now.
Ryssdal: So I have a confession to make, you ready?
Goldwasser: Sure.
Ryssdal: Before I bought my first house, I had no idea what my credit score was. I would not have known how to find it if you had told me. Are we now, in light of the credit problems we've had, paying too much attention to credit scores and if people just paid their bills and did what they were supposed to do financially, wouldn't everything work out?
Goldwasser: Well, actually it would. Your credit score doesn't really matter at all if you're not in the market for credit. I mean, it's going to fluctuate a little bit and it doesn't really matter. It's only if you're about to make a large purchase within the next six months to a year that you want to be careful about what your credit score is and make sure that you don't do anything that will harm it.
Ryssdal: Yeah, and then of course, by the time you figure it out and you're about to buy that house and you figure out you have a credit score of 427, it's too late.
Goldwasser: That's true. If it's that bad, you're in real trouble.
Ryssdal: Joan Goldwasser from Kiplinger's Personal Finance Magazine. Joan, thanks so much for your time.
Goldwasser: Very welcome.
The system does not differentiate between people who abuse credit and people who use cash and savings instead of credit. I have no cards, no mortgage, no car payments, and a very comfortable lifestyle because I have enough cash to meet my needs and more. However, my score is as low as someone who has many debts and never pays. This seems wrong since I've never paid anything late--rent, phone bill, car insurance, etc.
I suppose my biggest vindication is the fact that my family had no serious problems when the economy tumbled down.
Actually, I've never been late with a payment, my house is paid off and I've never bounced a check. My credit score was low however because I took out 2 store credit cards for the 10 or 20 percent off they afforded me at the time of purchase. Because I had done those in the past 2 years, my score was lowered. Further, my score was lowered because I didn't use those store accounts and their max credit was relatively low. I think it has to do with having a low credit limit on these cards (We're talking 2 here). Because of that I was denied a frequent flyer credit card.
My score had nothing to do with how I paid, it had to do with how much credit I had outstanding (paid off each month) and what those account credit limits are.
Your score goes up if you use a lot of credit, not your payment history.
When a single late payement can lead to a $10K difference in a home loan, or when a system dings you for just checking your score, or for actually reducing your use of credit and eliminating your debt, then it is not monitoring my "economic reputation" as Mr. Fair called it, but instead has become rulemaker, judge, jury and executioner of my ability to function in society.
To Mr. "Erik Fair" and his "reputation" speech, I say: "Fair Isaac" ISN"T. While simplistic concepts about keeping borrowers honest sounds right, in practice the Credit Score system is rigged. It is an intrusion upon fairness. The "ding" one receives for merely inquiring about credit-Unfair...The 'ding' for being 'late' presumes far too much about behavior; it is like having to pay $50 for a mere quarter or two absent from a parking meter. Mistakes and disputes are unreasonably difficult to resolve. Unfair. I suspect Mr. "Fair" is someone who enjoys the Power of Mr. Isaac-I say sack him...
People spending more might be the necessary engine of the economic recovery, but people spending money they don't have can't be. In fact, spending money we don't have is what got us into this fix in the first place; paying down debt rather than piling more of it up can only be good for the economy, at least in the long term.
Ms. Goldwasser is wrong when she says that your credit score doesn't matter if you're not in the market for credit. Credit scores are used as part of background checks of potential employees, and they're used by auto insurance companies as an input to the calculation of premiums, because credit scores and auto insurance claims are correlated.
The right way to think about the Credit History Bureaus (i.e. Experian, Equifax, & TransUnion) is that they're the keepers of your economic reputation, i.e. do you make good on your contractual commitments (mortgage, credit card payments, etc), or not? Credit scores are in part a simplified representation of your credit history, just as a grade point average (GPA) is a simplified representation of your academic record from school.
Once upon a time in small town America, one can imagine all the shopkeepers on Main Street talking to each other from time to time so that they know who amongst the townsfolk are the good and bad credit risks. Thus, if you stiff the General Store, odds are pretty good that the Blacksmith will hear of it, and demand cash on the barrelhead for goods or services you want to buy from him.
Modern day America is not that much different, except that you can't escape a bad reputation just by moving to a new town where no one knows you, because the Credit History Bureaus keep the record of your economic behavior (i.e. your reputation), nationwide. It's not a surprise, therefore, that this collection of information is being used beyond just credit risk management; it's your reputation.
