America runs on credit.
The three-digit score represents how likely a person is to pay his or her
bills, and it impacts almost every aspect of an American's financial life.
It's like your passport into everything that you need to do as an adult.
And it affects so many things, not just access to credit, so your ability to get
a credit card, a mortgage, a reasonable car loan.
Landlords use credit reports and credit scores, so it'll affect your ability to
get an apartment. Insurance companies use them.
Having a low or no credit score can have severe financial consequences.
42% of Americans said that their credit scores prevented them from accessing
financial products like credit cards or loans.
Life can become more expensive and more difficult as your credit score falls.
But some credit experts argue that the current credit reporting and scoring
systems have major issues.
The current credit scoring system as it stands is flawed.
And this error of being fundamentally misaligned has huge ramifications across
the system for millions of Americans.
Others say many of these criticisms are misguided.
The reality is that the credit reporting system that we have here in the United
States is sort of like the crown jewel of the world.
A lot of the criticisms are based on some fundamental misunderstanding of how
credit scores are calculated and how they're used.
If you take a moment to not be knee-jerk angry about financial
services for a minute, then I think a reasonable person would have to conclude
that these are actually good for consumers relative to a world without
credit scores and what that would mean to our bottom lines.
So how do credit scores work in America and do they help or hurt consumers?
A credit score usually refers to a number between 300 and 850, which
represents the holder's financial stability and creditworthiness.
The higher the number, the better a consumer looks to potential lenders.
Credit scores in the 500s are considered to be very bad.
Credit scores in the 600s, we're starting to use terms like subprime,
near-prime, getting close to average.
But you really need to get yourself into the 700s before you actually hit
the national average, which is between 710 and 720.
And then start working your way into the elite level scores, which are well into
the 700s and certainly into the 800s.
Credit scores and reports are two separate things.
Reports refer to statements containing information about your credit
situation, while scores are calculated based on that information from the
report.
The credit report is like the test you took.
The credit score is the grade you got on the test.
One is influential over the other, but they're not the same thing.
Today, scores calculated by Fair Isaac Corp or FICO have become the industry
standard, used by 90% of top lenders.
They're calculated using five main categories: 35% from payment history,
30% from the amount owed, 15% from the length of credit history, and 10% for
new credit and the types of credit you have.
It's based on an analytic algorithm.
So we look at actual data patterns to say what helps us predict
whether you're going to pay credit in the future.
One of the main benefits of having a credit score is that it provides a quick
and empirically sound method of measuring creditworthiness.
Americans are borrowing today more than ever, with household debt topping $16
trillion during the second quarter of 2022, making credit scores crucial to
many businesses.
It allows lenders to make very, very precise decisions and have a very deep
understanding of the likelihood of someone paying you back.
Experts say that such a streamlined process is also the reason why Americans
have been able to enjoy low-interest rates for so many years.
The credit scoring system allows the industry to quickly and cheaply
make decisions about whether or not you're going to have credit.
The cheaper it is for the lender to decide whether or not they're going to
give you credit, n the aggregate, the lower the cost is for the lender and
hopefully that gets passed along to the consumers in a more efficient system.
Without this system, lenders are going to do what lenders do, which is they're
going to mitigate their risk.
What that means in practical terms is higher interest rates because that's how
lenders mitigate risk - they charge everybody more to subsidize the risk
that's posed by everyone.
Or more declinations - it's easier to say no to an applicant than to book an
applicant who you know is going to default on a loan.
Representing a person's creditworthiness using numbers also allegedly helped
prevent lending discrimination.
Lenders often relied on more subjective methods of evaluation prior to the
invention of credit scores.
Credit scoring when it was first developed was an advancement.
It is better than having some banker sit across from you and judge you and
read the information in your credit score because they bring a lot of their
subjective analysis and their own life experience into the analysis.
And if their life is different than your life, frankly, if it's some white
guy sitting across from some woman of color, that analysis can be flawed.
If the information is not on a credit report, it is systemically impossible
for your credit score to be influenced by it.
What is not on your credit report?
Things like your gender, your sexual orientation, your politics, your level
of education, how much money you make, the socioeconomic makeup of
your neighborhood, your level of education.
So we're able to assess credit risk looking only at the past
behavior that is on the credit report and only to the extent that it predicts
future credit risk.
Yet, despite its good intentions, experts say that the credit scoring
system still suffers from discrimination.
A survey of 5,000 US adults found that more than half of black Americans
reported having a low or no credit score, compared to 41% for Hispanics,
37% for whites, and 18% for Asian Americans.
Credit scores are based on past performance.
So you're going backward in history to make a judgment about the future.
The further we go backward in history, the deeper the structural racism in the
United States was.
Intentional Racism that happened decades ago gets baked into the cake, into
the system, into the institutions and policies of our society.
And that kind of structural racism requires no animus and no intent, but it
still hurts black and brown consumers.
If your parent put your name on a bill because they had bad credit and then
they were delinquent, you can turn 18 and inherit derogatory information on
your credit report through nothing that you did.
If you're a new immigrant in this country, your prior credit history
doesn't travel with you.
These credit bureaus are mostly domestic, so you show up with nothing.
And by the way, a blank slate is a bad place to be in credit scoring.
It means that you're un-scored and your information starts off low and poor.
19% of American adults have no credit history or are considered unscorable by
existing systems.
Sadly, what the scores do is they sort of amplify those inequalities because
they go in and they say, 'Okay, you're already disadvantaged.
Now you can be doubly disadvantaged' because the score then sort of
objectifies that you are somehow not worthy of being given a
chance, that you are somehow deserving of much higher fines and
fees than everyone else.
Errors in credit reports can also often lead to miscalculated scores.
A survey in 2021 found that more than a third of those polled found errors in
their credit reports.
Of more than 700,000 credit or consumer reporting complaints received in 2021,
more than half pertain to incorrect information on their report.
For me, it was a different person named Aaron Klein who didn't pay their cell
phone bill in New Jersey.
I also happen to live in New Jersey for graduate school, and this stuck with me
for a year.
One in 20 have an error so serious it could cost them either the ability to
get credit or a job or an apartment.
However, those within the industry argue otherwise.
When we look at our data, it is astronomically reliable.
So we're constantly auditing and evaluating our data.
Our regulators are examining us on a regular ongoing basis.
So they're looking at all of our systems around data integrity, data
reliability, how we engage with consumers, etc,.
Under the Fair Credit Reporting Act, credit bureaus are responsible for
correcting any inaccurate information on their reports.
But research has suggested that many consumers find errors difficult to get
fixed.
Credit bureaus are like a judge that always rules for the defendant.
So if your mortgage servicer says you're late, even though you really were
never late and you have documentation that you were never late, it will still
show up as late.
Fixing mistakes is expensive and time-consuming for the credit reporting
and credit scoring industry.
They are not incentivized to have accuracy, particularly if the mistakes
are symmetric and even out.
Our entire role in the consumer credit ecosystem is to provide reliable,
accurate information.
If we were unable to do that, nobody would have any interest in engaging with
us whatsoever.
Our position is that the system only works and we can only succeed if our
data is incredibly reliable and accurate.
And that means engaging with consumers continually to try to make sure that
they're able to effectively managing their credit and that they're able to
effectively feel as though they can interface with us about any concerns
that they have.
Another main concern is the lack of regulation and oversight that can ensure
fairness and transparency within the industry.
You know, I think the idea that the industry is unregulated is a fiction.
And we operate in one of the most highly regulated spaces possible.
You have a 50-year-old federal statute called the Fair Credit Reporting
Act, which essentially mandates everything having to do with credit
reports from our rights to challenge information, our rights to freeze our
credit reports, our rights to get copies of our credit reports.
You have the Consumer Financial Protection Bureau, which regulates
credit bureaus vis a vis credit report accuracy.
You have the Federal Trade Commission that shares that regulatory
responsibility.
I must say that the Consumer Financial Protection Bureau, which took over
oversight of this industry about ten years ago, they've done a really good
job of trying to reform the credit bureaus.
But I would go further than more regulation or even more laws.
Over the years, credit reporting and scoring agencies have made several
changes in response to the criticisms against the industry.
Perhaps the biggest change comes from the use of alternative data to improve
accuracy and inclusion.
They've started trying to incorporate other, quote-unquote, nontraditional
information. For example, if you pay your mortgage on time every month, your
credit score is going to increase.
But if you pay your rent on time every month, nothing happens because that
information isn't reported.
We've innovated with scores like the FICO score XD and the ultra FICO score.
They augment traditional credit data with rich alternative data, such as how
you pay your telco, utilities, as well as information that's in your checking
and savings account.
The point of these new scores is to allow consumers to find other ways
besides the historical credit to demonstrate their ability to repay
credit.
More regulatory changes could also be coming.
Two bills, the Protecting Your Credit Score Act and the Comprehensive Credit
Act, were both passed by the House in 2020, aimed at overhauling the credit
scoring system with more oversight and provisions aimed at protecting consumer
credit. They have yet to be put on a vote by the Senate.
One of the initiatives that we're championing because we really think the
solution to a lot of these concerns around how do you help consumers access
financial products is an alternative data piece of legislation called the
Credit Access and Inclusion Act, which would really encourage the reporting of
rental data, utility data, bring new data into the system that would allow
literally millions of Americans to access financial products and services.
But ultimately, credit in its current state is dependent on the consumer's
financial decisions.
I'll tell you the two things that you need to do, and it will be impossible
for you not to have a good score.
Number one, never, ever miss a payment on anything, ever.
That's easy. It's writing a check at the end of the month and paying your
minimum payment, right?
Number two, you've got to stay out of credit card debt.
And I'm not saying don't use credit cards, I'm saying don't max out your
credit cards. Don't use th as a supplement to your income or to keep up
with the Joneses or to impress somebody.
Pay your bills on time, stay out of excessive credit card debt, lather,
rinse, repeat, and you're going to have fantastic credit scores.
You know, 'how you manage your credit is a sign of responsibility.' It's not.
A lot of people have negative items on their credit report because they were
the victim of bad luck, not because they're bad people.
So they got sick, they lost their job and now they can't pay their bills and
their credit report is going to stop them from getting a new one.
That's crazy.