Financial Freedom

“It is the purpose of this title to require that consumer reporting agencies adopt reasonable procedures for meeting the needs of commerce for consumer credit, personnel, insurance, and other information in a manner which is fair and equitable to the consumer, with regard to the confidentiality, accuracy, relevancy, and proper utilization of such information in accordance with the requirements of this title.”

In the words of the U.S. Congress, the previous paragraph is the purpose of the Fair Credit Reporting Act (FCRA). In short, the Fair Credit Reporting Act is designed to help protect consumers against unfair practices within the credit reporting system.

While the mission of the FCRA was a noble one, a quick look around today’s credit society shows the results have fallen well short of expectations. What follows is how the FCRA has failed to produce a fair credit system for today’s consumers.

Detailing the Failures of the Credit Reporting System

Accuracy – It is well documented that credit reports contain errors but it bears repeating. Recent studies show that almost 80% of all credit reports contain factual errors such as duplicate listings, incorrect dates, tradelines placed on the wrong person’s credit reports, and omitted positive credit accounts.

These studies also indicate that 25% of credit reports containing errors significant enough to result in a credit denial.

How fair is a credit system that can cause a person to get declined for a loan or force them to pay higher interest rates than are necessary based on their actual credit risk? True, you have the right to dispute these inaccurate items with the credit bureaus, but this chore is not necessarily easy or foolproof. Depending on the nature of the erroneous items on your credit reports, credit repair can be a frustrating and time consuming ordeal that you are forced into because of no fault of your own.

Relevancy – While they do not say it directly, the credit bureaus’ creation of the VantageScore is evidence enough that the current FICO based credit scoring models are not as relevant as they could be. According to Experian spokesman Donald Girard, the VantageScore is “the most sophisticated, highly predictive scoring model that’s available in the marketplace” and as a consequence the much more popular FICO score is less predictive.

One of the flaws in the FICO score that the VantageScore tried to fix is the impact that very old credit accounts have on the credit score. According to Dr. Bonnie Guiton Hill, advisor to President Bush on consumer affairs, “it is our understanding that computer models that predict credit worthiness find most information that is more than two years old nonessential.” This is why newly created scoring models like the VantageScore are beginning to ignore credit information that is over three years old. It does not serve to accurately determine your credit risk.

So why have lenders been so slow to adopt scoring models such as the VantageScore? They claim it is because FICO is ingrained in the current credit system and has stood the test of time. A more cynical answer is that these lenders are not willing to sacrifice the huge profits they make from charging higher interest rates on loans granted to people who are a relatively low credit risk.

Of course, this cynicism is not simply the result of a general and unfounded grudge. It is born from the observation that seemingly every quirk and inconsistency in the credit reporting system falls in favor of the lenders. For example, when looked at logically, it makes sense to close unused credit cards. Not too long ago, financial experts suggested people do exactly this to make your credit score look better by showing your lack of need for unsecured credit.

But now we know that closing those accounts can actually lower your credit score because FICO rewards you for having multiple accounts and a large amount of credit at your disposal. So while closing accounts seems to be the financially responsible thing to so, it is probably more than an odd coincidence that this behavior which makes you a less profitable consumer for banks and credit card companies it punished by FICO.

The same goes for paying off installment loans early and voluntarily lowering credit limits. Both of these actions seem inline with what we would expect from the ideal consumer, but neither will have a positive impact on your credit score. Early payment of installment loans, another common goal of a financially responsible consumer that diminishes the profits of lenders, is not noted on your credit reports. And contrary to what you would think, lowering credit limits would lower your credit score because as alluded to above, you are rewarded for having multiple credit accounts and lots of credit at your disposal.

But by another quirk of the FICO credit scoring model, you are rewarded for having multiple credit accounts, but you are punished for seeking new credit. Consumers are told that inquiries are added to your credit reports each time you apply for credit so other lenders can see that you may be overextending yourself or crashing. But isn’t it convenient that inquiries will lower your credit score at the exact time when you are looking to qualify for new lines of credit? FICO wants you to have multiple lines of credit, but in trying to appease the scoring model, you will temporarily lower your credit score allowing lenders to charge you higher interest rates.

It seems no matter what you do, the deck is stacked against the consumer.

So while the VantageScore is a step in the right direction, it is still a long way from producing truly relevant results. This is because the VantageScore maintains many of the same scoring quirks exhibited by FICO and still uses the same basic, and very limited, variables for determining your credit score such as payment history, amounts owed, and length of credit history.

Your credit score is found by taking these variables as recorded in your credit reports, plugging them into a predictive model, and calculating a single three digit number. A late payment for example will be entered into the formula and will lower your credit score a set amount based on the amount of time it was late and how long ago the late payment was reported.

The fundamental flaw in this model, however, is that there is no accounting for why the payment was late. Whether you were late in making a payments because the lender did not send you a bill, because the bills were sent to the wrong address, because you wrote the wrong amount on the check, because your checks bounced, or because you blew all your money on illegal drugs; it is all the same in the eyes of the credit scoring model. Even if you have a sloppy lender to blame for your late payments, your credit worthiness in the eyes of lenders will be the same as a person saddled with a serious drug addiction.

Proper Utilization – Given how common it is for a credit score to be a gross misrepresentation of a person’s credit worthiness, it could be argued that the pervasiveness of credit scores in the financial market is improper. But in today’s society, the use of credit scores goes well beyond determining loan amounts and interest rates.

Employers, landlords, insurance companies and others may request to see your credit score. In today’s society your ability to get a certain job, rent an apartment, or qualify for reasonable insurance premium can all be dependent on your credit score.

Improper is a subjective term, but being passed over for a job because of completely irrelevant and possibly inaccurate negative credit items in your credit reports that are plugged into a flawed credit scoring model to produce a credit score that is not indicative of your actual credit worthiness fits the bill.

The FCRA Made Improvements, but there is Still a Long Way to Go

The FCRA’s failure to produce a system where the “accuracy, relevancy, and proper utilization” of your information is protected has resulted in a credit reporting system that is hardly “fair and equitable” to you as a consumer. But in defense of Congress, the FCRA has been heavily influenced by deep-pocketed industry lobbyists. In fact, when the FCRA was originally passed in 1971, Senator William Proxmire, one of the bills primary sponsors, felt defeated at what had become of his original intentions for the bill.

Since that time, the FCRA has been amended to become more and more consumer friendly, but there is still a ways to go and as was the case in 1971, those in the credit industry are still keenly interested in maintaining the status quo.

While the credit bureaus are no longer able to record information about you such as your ethnicity and religion, they also are not required to collect other personal information that is relevant to your credit worthiness. If you are a model citizen who has worked with the same company for 10 years, has a perfect criminal record and makes more than enough money to cover your expenses, it is fairly obvious that you are more worthy of credit than a career criminal who is a continual burden on the system. But none of this information is recorded by the credit bureaus or used when calculating your credit score. If you and the career criminal have the same types of accounts on your credit reports, your credit scores will be the same.

Also, while you now have the ability to see what information is contained within your credit reports, you do not have the ability to learn any more than the very basics of how this information is used to formulate your credit score. What impact will paying off a past due debt have on your credit? Which credit cards should be paid down first? What effect will shopping for a new loan have on your credit score? We have vague, observation based answers for these questions, but the exact formula is unknown and is subject to change at any time.

Finally, you have the right to dispute the questionable items in your credit reports, but you don’t have the right for this process to be easy or necessarily effective. Depending on your unique situation, credit repair can be as easy as submitting an online form or as difficult as tracking down creditors, fighting with collections agencies, and possibly involving legal intervention. The very entities who profit most from inaccurate credit reporting are the ones who played such a big role in watering down the FCRA and continue to resist consumer attempts to add equity to the credit system. It is these entities you are forced to contend with when working to enforce your right to a fair and accurate credit report.