It is time to "rework" the Credit Rating System

Great Debates
1

Forgetting for the moment that the current system has a wonky range ending at a top score of 850, the logic is outdated at best and actually seems somewhat counter intuitive.

Case in point:

I was preparing to do a refinance of our home. Started with a credit score of 787. I decide that I want to go ahead and pay off my newer truck loan to get my debt to income ratio under 25%.

So I pay off the loan and wait a month before I contact our mortgage company only to find out that the “closed account” actually hurt my score by 6 points! This coupled with 2 points off for my ONLY hard inquiry in 3 years and I go into my refinance with a score of 779.

Now I understand that having “aged” and available accounts are good for your score. But why ding someones credit for removing 3 year old auto debt?

And I get that hard inquiries CAN show someone desperate for credit which is a red flag but you HAVE to take on one for a refinance. So why not allow 1 or 2 a year with no penalty then start taking points off?

After this experience, the Credit System in America seems about as logical as the NFL’s quarterback rating!

2

You’re looking for ‘cause and effect’ in the algorithm that is used to generate your credit report.
That would imply that it was some kind of moral, rational system.
That’s not how it works.

The system was generated by feeding in a ton of credit report data, along with data on whether or not the associated consumers eventually wound up defaulting on their responsibilities.

You wind up with this weird computer system that’s looking for things that CORRELATE WITH, not cause, consumer defaults.

Incidentally, you shouldn’t sweat the 6 points here and 2 points there stuff. As long as you’re in the top bracket, and you look to be, the outcome will be the same. No brownie points are awarded for having an 845 instead of an 830!

On edit:
PS- IIRC, the main FICO scoring system most of us are talking about when we say ‘Credit Score’ started out by being fed data on the odds of a mortgage going into default within the next 7 years. That the only thing the stupid score was supposed to predict.
PPS- Actual lenders tend to use different credit scores than what we see. For instance, there’s a score designed purely for auto lending… I suspect MULTIPLE scores just for auto lending.

3

Moved to Great Debates from GQ.

Colibri
General Questions Moderator

4

We discussed this as a sort of side issue in this thread. I totally agree with you - this system is ridiculous.

5

You’re operating on the assumption that the purpose of the credit rating score is to determine how creditworthy you are. It isn’t.

Its purpose is to determine how valuable a credit customer you are. By paying your truck off early, you proved yourself to be s slightly less valuable customer. People who pay car loans off early produce less profit for the lender, because you avoided paying all the applicable interest. You would have maxed out their profit by making all the payments on time, but not early. That would have kept your score up, or at least maintained it.

Ben Stein probably has a worse credit score than you do. (Stein is famous for his love of using credit cards to get points without ever carrying a balance.)

6

Is that also why people get dinged for repeatedly having their credit checked? “He shops around for the best deal? That’s a red flag right there!”

7

You aren’t being dinged for shopping around, you are being dinged for multiple attempts to get credit. The assumption being either that the other lenders have rejected you, or that you are trying to take out multiple loans at the same time. Either way you become more of a risk.

How ever, most lenders will take that into account. If you are getting a mortgage, you’ll obviously need to ask around to a few places. But if they see 20 hits it seems like something is off.

This is not correct. First off, when you pay back a loan the lender can find another borrower, they aren’t about to just sit on that $10k, so they will continue to make profit. Secondly, many loans have an origination fee, so the more times they can lend that $10k the happier they’ll be.

8

Cite?

9

This is incorrect. FICO (and other credit scoring models) are for risk analysis. Lenders have plenty of other fancy models for determining your value in other ways.

I guarantee you Ben Stein has an excellent credit score.

10

No. This would be a reasonable assumption, but the truth is that humans don’t control the logic inherent in the system.
There is a correlation between having more than X inquiries and a higher rate of default.
That’s the only thing that matters to the algorithm. It doesn’t care that the inquiries are due to you being a savvy rate-shopper, or previous rejections, or anything else.
A human set up a system that looks for correlations. Past that, there wasn’t any human intervention in setting up the scoring system.
The damned thing is like Skynet now.

Lenders have their own decision-making systems that help them lend sanely. Those existed before credit scores, and have not gone away.
That being said, multiple hard inquiries during a set period of time count as one inquiry.
This isn’t the best cite, but I can find more if you like:
http://www.creditcards.com/credit-card-news/simon-credit-check-inquiry-fico-score-1508.php

11

Yeah. Ditto. Almost everybody I know with great or near-perfect credit ratings have paid off their credit cards monthly. The idea that you have to carry a balance or pay interest to get a high score is nonsense.

12

In my lending experience, this isn’t true. Yes, they can loan out the money again, but that means they’re rolling the dice again on a new person who hasn’t paid any interest yet and might never pay anything at all. A world where 80% of people pay and 20% default is better than one where 60% of people pay, 20% default, and 20% pay off early.

The origination fee may be profitable- I don’t know - but I bet it exists more to make up for early payers than to generate a big part of a business’s income.

13

Revamping a credit score is to minimize credit risk (minimizing default which leads to losses.) A score predicts likelihood of default and if defaults occur where the score says it shouldn’t, you have type 1 errors that need to be corrected (some risk areas are not given enough weight, or something is left out entirely.) You might also get good feedback from other lenders about a borrower (one or several) who failed your scoring. This is a type 2 error that also needs to be ironed out.

A good scoring system considers only risks that result in losses. That’s why security and collateral arrangements often do not enter into the model. They reduce or prevent losses despite a default.

Pre-termination, and the losses that come as a result, is often not considered a credit risk but an issue of account profitability. Simply put in penalties for paying ahead of contracted schedule. But clients with a long established borrowing relation are often spared this.

14

First, there isn’t “a credit system in America.” That is, there is no national standard to determine loan worthiness. There are a handful of private firms who do credit reporting. Equifax, Esperian and TransUnion are the best known. (And I think Experian isn’t even “American” per se.)

These firms sell–among other things–a rating system that helps lenders decide how likely someone is to default on a loan, and as mentioned above, they are looking at correlations typically, rather than individual situations. Folks that are often late on payments are more likely to default, even though a given individual might be often late because she is discombobled about how she pays her bills.

Because these firms sell a proprietary service, they are loathe to give out their exact formulas. I’m a typical geezer who has become obsessed with keeping my scores above 800, and I completely agree that in the credit “system” many things become counter-intuitive.

The credit-rating scoring used does not look at your balance sheet, which would be the most intuitive “system” for most people (along with their debt/payment history). The credit agencies have no way of knowing that you have $20M in Apple stock and are good for any loan you make. They are focusing on one thing, really: What is your payment history? They also look at a second thing: What is your total line of credit compared with how much of it you are using? A person who has tons of credit lines, uses almost none of it, and always pays off outstanding balances every month might have better credit scores than a rich guy with one CC. The rich guy would still have an easier time getting a loan, because a credit score is only one data point on a loan application. I just want that 850 so I can frame it (and I’m wondering if that really is the top number…)

If you had an outstanding car loan with a great payment history and a balance of 3K on an original 25K line, and you close out the loan, in theory your credit score might dip a little because you now have 22K less credit line than you had before, and one measure is how much of your total credit line you are actually using. If you are making a dozen actual credit applications and get all those “hard” inquiries, that’s a red flag too. Both those are kind of counter intuitive. I’ve also been burned by putting everything on a CC (to get points) and then paying it off monthly; the CC report says my monthly balance was too high, even though I paid it off every month. Ridiculous. (I finally got around that by paying off my CC balance every few days electronically).

Net net, though I think the system works OK. I’m obsessed with trying to get my scores to the very top, but I am beginning to think it is not possible. I agree that anything over 800 more or less gets you the best loan deals, assuming your balance sheet is clean, but since we don’t have any loans, that doesn’t help me.

15

I found out the hard way that there are at least two score ranges in use. One goes up to 800, the other, 900 (approximately). So a score of 787 in one system isn’t nearly as good in the other, and they don’t tell you up front which one is in use.

I had my score checked once, then re-checked with a different source about a year later. I was pleasantly surprised to find my score had gone up 50 points, but more surprised to find out it really hadn’t; I had merely jumped from one scoring range to the other.

I certainly agree some reform is needed and it needs to be an open formula so we can know how it is calculated and how to modify it.

16

Pretty good explanatory article here.

17

It isn’t. TRW used to do credit reporting. (Hence, ‘TRW report’.) They sold the data reporting business, which used the TRW name until they could come up with a new one. They chose ‘Experian’ from a list provided by one of those ‘name your business’ companies. (The name reminded me of the Hyperion sewage treatment plant, which overflows every time it rains. :stuck_out_tongue: ) The American (IIRC) holding company sold it to Great Universal Stores (GUS) in 1996, and its headquarters was in Nottingham, England. Three years after half of our department (including me) was laid off when the ironically-named Tata Corp (an Indian conglomerate) took over some of our functions, GUS was split into Home Retail Group and Experian. Experian’s worldwide headquarters is now in Dublin, Ireland.

18

FICO (the most commonly used scoring model) goes to 850. The Vantage Score goes to 990.

ETA: I should have added an explanatory link here. Oh, and this one, too.

19

Oh, and there is also the Experian Plus score, which goes to 830, and is apparently not even used by lenders.

If you want to know your FICO scores, which most lenders use, AFAIK, you have to check on myfico.com. These scores are most likely what your lenders see. Oh, and there is also the FICO NextGen score which goes to 950.

Ah, here’s a chart which breaks down some other scores.

20

I swear, it looks like those companies went out of their way to make their systems have the most numerically arbitrary minimums and maximums.

VantageScore: 501-990
TransUnion: 150-934

What are these people smoking?

If I was a banker, I would not consider these systems “confidence inspiring.” They look like they were set up by 4th graders.