Lenders Begin to Look Beyond FICO

A few years ago, Fair Isaac reported that the average FICO credit score in the U.S. was 723 out of a possible 850. The higher the score, the greater the likelihood that the borrower would repay a loan.

At least that was what Fair Isaac pitched to lenders.

Thus spawned several years of streamlined loans – loans that were predicated solely on credit score. "Stated" loans allowed people with good credit scores to put down any income figure on a loan application and get approved. The sheer number of applications in an overheated market where an hour could mean a $50,000 difference in selling price necessitated glossing over details that were mandatory – or at least a consideration – in pre-FICO days. (I know you're thinking, what, there was a time when credit scores didn't exist? Credit scores weren't developed until the late 50s.)

According to an article in Time magazine,

A few years ago, Fair Isaac produced a chart predicting the odds that a borrower with a certain credit score would default on a mortgage. For example, it predicted that a loan to a borrower with a 680 score had a 1 in 144, or 0.7%, chance of becoming delinquent over the life of the loan; a person with a 700 FICO score would have a 1 in 288 chance, or just 0.3%.

Unfortunately, those predictions proved too optimistic. According to mortgage-data tracker First American Loan Performance, banks have already foreclosed on or are in the process of foreclosing on 1.5% of the mortgages originated in the last three months of 2007 to individuals with credit scores between 660 and 720. And those mortgages have been around for only a year. Over 30 years, the delinquency rate on those home loans is likely to be much higher.

The rise in defaults among "good credit" borrowers is beginning to force lenders to revert back to more traditional ways of predicting risk. Consumer advocates who have long opined that a three-digit credit score managed by for-profit entities is an inaccurate measure of creditworthiness should be pleased at this trend, which takes a number of variables (such as phone bill payment records) into account - especially helpful for those borrowers with thin or non-existent credit histories.

Shopping for Student Loans Damages Credit Scores

Fact: Too many credit inquiries can damage your credit. That's because the credit scoring formulas assume that the borrower is financially troubled and may even be going bankrupt.

Fact: If you comparison shop for a mortgage or car loan to try to get the best interest rate, FICO's secret credit scoring algorithms lump together all related inquiries that occur within a short period time. Such credit inquiries have a relatively neutral impact on credit scores.

Fact: The New York Times recently reported that students and parents shopping for the best rates on private student loans DO NOT benefit from the same type of calculations as those shopping for home or auto loans. Translation: each time you compare a new student loan, your credit file gets dinged with another inquiry. Each inquiry can drop your score up to 5 points.

It's a bad equation for students and parents:

Too many inquiries = lower credit score.
Lower credit score = higher rates on student loans.

If you have a thin credit history (as many students just getting out on their own often do), such inquiries may have an even greater impact. Anyone who has shopped for a mortgage knows that a measly five points can make a big difference in qualifying for that higher tier interest rate break.

Apparently the New York State Attorney General's office has stepped in and asked Fair Isaac, creator of the FICO score, to treat student loan borrowers the same as those shopping for mortgages and car loans. The Times reports that Fair Isaac isn't changing its policy any time soon and believes its policy doesn't cause any damage most of the time.

However, at least one credit bureau – Experian – confirmed that that this policy may have an impact on credit scores. And a spokesperson for Sallie Mae, the nation's largest private student loan lender, says the company does, in fact, see the negative impact on credit scores and believes that students should not be penalized for trying to make smart financial decisions.

The Times still recommends comparison shopping with 3-4 lenders, preferably within a week or two. Fair Isaac did say that IF there is any negative impact on credit scores, it is more likely to occur when people apply to smaller or specialized student loan lenders, and a lesser impact when applying to big banks.

The Times' advice:

"Start with a lender or two that your college recommends, since it may have negotiated special terms with them... [shop] one bank, one finance company that specializes in student loans and then [look] for nonprofit loan agencies that work with people in the state where you live or the state where you attend college (or both, if you’re lucky enough to have a choice)."

Check this list of lenders or ask people in the financial aid office whether a nonprofit lender serves the college.

Banks Are Putting Credit Cards on Ice, Too

If you've got a credit card "just for emergencies" that hasn't been used for an extended period of time, you may find that when that emergency does come, your card is no longer good.

According to a report by Smart Money, the soaring number of credit card delinquencies has banks trying to reduce their exposure to risky or unprofitable accounts. And it's been suggested that the Fed's proposed new rules restricting the banks' ability to arbitrarily raise interest rates and give consumers more time to make payments may be triggering an increasing number of credit card closures.

Even if you don't rely financially on your credit cards, closing credit lines can hurt your credit score. That's because your FICO score depends in part on your credit history and the amount of available credit you have compared to the amount of debt. If the card that is closed is the one you have had the longest, your score will certainly drop. And reducing the amount of available credit you have will have a negative impact on your debt-to-available credit ratio, which will decrease your score.

So... use your backup credit cards occasionally. If you've had a card issuer close your account, and you want to keep it open, contact the company and ask them to reconsider.

FICO Says… You Can't Have Too Much Credit

Once upon a time, not so long ago, having lots of available credit meant that you were "inevitably" doomed to go on a massive spending spree of epic proportions. Each unused dollar was a ticking debt time bomb, because even responsible users of credit would surely be lured into the vortex of temptation caused by those shiny cards with winking holographs.

But while conventional wisdom held that excessive credit – even unused – was a liability, Fair Isaac says there is no such thing as too much available credit when it comes to how they score credit. In fact, Fair Isaac's Barry Paperno states, "There really is never any good reason to close an account."

Three reasons why NOT to close an account:

1. The FICO score does not penalize you for having too much available credit. (Opening a bunch of new accounts may be a problem, but by itself, available credit is not a factor.)

2. While closing an account does not immediately eliminate all of the history associated for that account, the bureaus will automatically remove a closed account in 10 years (or less, if the credit card issuer decides to remove it). History – or how long you've had credit – accounts for 15% of your score. If you close an account that you've had for a long time, and your only remaining credit history is from credit cards or loans that were opened recently, it will negatively impact your score once that account falls off your report.

3. Closing an open account with a good history may negatively impact your ratio of balances-to-limits. Say, for example, that you have four cards with credit limits of $2,000 each, for a total available credit limit of $8,000. If you owe $1,000 on three cards, and you close the fourth, your debt ratio will increase from $3,000:$8,000 (37.5%) to $3,000:$6,000 (50%). This ratio accounts for 30% of your credit score. The higher the debt ratio, the lower your score.

What is my REAL credit score?

Dear Credit Mama,

I've been working hard to pay all of my bills on time and have almost paid off my credit cards. I want to see if my efforts have made my credit score go up. I've looked into buying my credit score online, but it's confusing because different companies have different ranges for what your credit score could be – some have scores that go to 850, some go to 990. What's the deal? And which one should I believe?

--Angie, St. Louis, MO



Dear Angie,

Very astute of you to notice this! You are right – not all credit scores are the same.

The "FICO" score was invented by Minneapolis-based Fair Isaac Corp. in 1988 as an attempt to quantify the odds that borrowers will repay loans on time. The company’s name is derived from those of Bill Fair and Earl Isaac, an engineer and a mathematician, who created the credit scoring concept and founded Fair Isaac in the 1950s.

FICO scores range from 300-850. FICO calculates your score using the following factors:

• 35% payment history
• 30% amount owed
• 10% tpes of credit in use
• 15% length of credit history
• 10% new credit

"Vantage" scores, dubbed "FAKO" scores, were developed by the three credit bureaus and introduced in 2006 to compete with FICO scores. Because they do not have the actual FICO formula (a secret as closely guarded as Coca Cola's recipe), they are only approximations of the FICO score.

Vantage credit scores range from 501-990. Each 100-point interval corresponds to a letter grade, in ascending order. A score of 501 to 600, for example, would translate into a grade of "F", while someone with a score greater than 900 would receive an "A." Vantage calculates your score using the following factors:

• 32% payment history
• 23% utilization of available credit
• 15% credit balances
• 13% length and depth of credit history
• 10% recently opened credit accounts
• 7% available credit

FICO Vs. FAKO

Consumers usually buy their credit scores from the credit bureaus – the VantageScore. However, Fair Isaac states that most lenders (90% of the 100 largest banks) use the FICO score. (To complicate matters, some lenders create their own variation on a FICO score, adding in their own criteria.) Your "FAKO" scores can differ from your FICO scores by as much as 50 points.

More than two-thirds of all consumers qualify for a grade of "C" or higher. FICO scores, by contrast, range from 300 to 850, with 85 percent of Americans coming in at higher than 600. If you found a score of higher than 850 then you are "buying" one of the other scores - not the FICO score that lenders use.

Fair Isaac has filed a federal antitrust lawsuit against the nation's three credit bureaus, alleging they are "misleading and confusing consumers" when selling their own version of the credit score. They contend that since Equifax, Experian and TransUnion own the consumer data it uses to create the FICO scores, they could "unfairly manipulate the credit score price, sales and distribution process" to promote VantageScore.

The bureaus claim that the new scoring model increases competition, giving more choices to credit grantors and consumers.

Having more scoring options is good for lenders, but not necessarily good for consumers. With multiple scoring models, the odds increase that a lender can find a score to use to declare you a subprime candidate and increase your rates.

If you are trying to qualify for a mortgage or other major loan, you will want to access the real FICO, not the FAKO. Our friends at mycreditroadmap.com can link to you a FICO credit reporting product that will give you reports and scores for each of the three national credit bureaus.

So What IS the Average Credit Score, Really?

I was reading an article today posted by BusinessWeek called "Buying a Franchise with Bad Credit." One of the first things that struck me was the reference to average credit scores. A nonprofit contractor for the SBA microloan program says,

"Usually they have what I'd call an average credit score—in the mid 500s or 600s—but not a high credit score."

But hold on a minute! The credit bureaus say that the average credit score in the U.S. is 692. (In case you didn't know, FICO scores range from 300-850, although other credit bureaus use different scales.) In fact, Fair Isaac says on their Web site (myfico.com):

"About 40% of credit card holders carry a balance of less than $1,000. About 15% are far less conservative in their use of credit cards and have total card balances in excess of $10,000. When we look at the total of all credit obligations combined (except mortgage loans), 48% of consumers carry less than $5,000 of debt. This includes all credit cards, lines of credit, and loans-everything but mortgages. Nearly 37% carry more than $10,000 of non-mortgage-related debt as reported to the credit bureaus. " They report that 58% of consumers have a credit score of 700 or more.

Yet the data from Federal Reserve says something very different:

"The average household has $11,000 to $12,000 in credit card debt... Those figures are diluted by those who don't hold any debt. Households that carry debt from month to month carry close to $17,000 of unsecured debt on average. One out of every five households is either behind on payments or over the limit on at least one account."

To make matters worse, not only is the rate of foreclosures at an all-time high, but it is projected that 10% of home owners (approximately 8.8 million people) will have negative equity by month's end.

Hmm. According to the bureaus, 30% of your score is determined by your debt ratio: how much money you owe, divided by the amount of available credit you have. Thirty-five percent of your score is based on payment history. In total, that's 65% of your score - and the data shows that the majority of American households are not doing so well in these two areas.

Now factor in the sneaky credit industry tricks -- universal default (where credit card issuers can raise your interest rates should your credit falter - even if you have never made a late payment), interest rate increases for no reason, not reporting your true credit limit on cards, "chasing balances" (where credit card companies reduce your credit limit as you pay down the card) -- and it's clear that the average consumer's credit score is being attacked from so many angles that an "average" credit score of nearly 700 is improbable.

Ask any residential mortgage broker or loan officer if their average applicant's credit score is 692. Just be prepared for the snickers or guffaws.

My business partner was speaking with a mother of three the other day. As she was talking about her credit, her demeanor completely changed - her shoulders slumped forward, head hung low, voice full of apology. She truly believed that she "deserved" to pay higher interest rates because of her "poor credit." Yet if she knew that the majority of people had credit scores in the same range as hers, would she be so accepting?

Will the Doctor Still See You After Looking at Your Credit?

Every 30 seconds in the United States, someone files for bankruptcy in the aftermath of a serious health problem. According to a Harvard study, illness and medical bills are the cause of half the personal bankruptcies filed in U.S. An estimated one million Americans are financially ruined by illness or medical bills each year - more than half of them are college educated, homeowners, with good jobs. Surprisingly, more than 75% were insured at the start of the bankrupting illness.

Now I'm going to throw another number at you: 80 percent. That's the number of hospital bills that contain multiple errors, according to the Medical Billing Advocates of America.

Here's one final stat: 250,000. That's the number of medical identity theft victims reported to the FTC each year.

Now there is talk of a medical FICO score being developed by a company called Healthcare Analytics. Like your credit score, which calculates the level of risk via algorithms and the consumers' credit history, the medical FICO score calculates which patients are more likely to pay their medical bills. Healthcare Analytics is already gathering payment information from large hospitals around the country.

Supposedly the benefit of a patient scoring system is to help hospitals decide whether to write off some delinquent bills as charity cases rather than report them as delinquent accounts. According to msbnc.com, American hospitals face $40 billion in unpaid bills every year.

But with so many people already uninsured (47 million in 2007), and with out-of-pocket costs rising, and two million people filing bankruptcy each year due to medically-related issues, this medFICO is a serious concern for consumers and privacy advocates.

Add to that the frustrations of inaccurate billing, and you've got the same headaches as with the credit bureaus - who also have a dismal 79% error rate (nearly 8 out of 10 credit reports contain serious errors).

Will the doctor or hospital decide not to perform certain services or provide inferior care (ie: reducing the length of stay) after looking at a patient's medFICO score? Will an employer decide not to hire someone because they are too expensive to insure? They SAY these things won't happen, but the risk assessment industry is too lucrative for this information NOT to be used in other ways.

Who is Healthcare Analytics? The investors include Fair Issac Corp. (founder of the FICO scoring model) and Tenet Healthcare Corp., one of the nation's biggest hospital operators. Former Tenet CFO Stephen Farber is its CEO.

The product is not expected to launch commercially until the end of this year.

Don't ever give your SSN to a healthcare provider. They do not need it. They need your member number from insurance, not your SSN. Furthermore, it's illegal for them to ask for your SSN unless they are going to lend you money or hire you.

How Will FICO's New Scoring Model Affect You?

Last summer, a little-known Internet-based company based in Florida was thrown into the national spotlight for its ability to "trick" the credit bureaus' credit scoring programs. Credit-challenged customers signed up with the company, who added them as authorized users on the credit cards of people with sterling credit. It seemed to be a win-win for everyone - the clients, who normally paid upwards of $1,000 for the service, got a boost of 30-200 points almost overnight; the original card holders were paid handsomely for allowing clients to piggyback on their good credit history. The losers? The credit bureaus and lenders.

As promised, Fair Isaac Corp., creators of the FICO credit score, will launch a new scoring model this spring. One of the major changes is the exclusion of these types of authorized user accounts from their credit score calculations.

According to Fair Isaac, 30% of the population has an authorized user account - approximately 60 to 75 million borrowers.

Since length of credit history accounts for 15% of one's total score, if the authorized account is the first (or only) type of account that the borrower has, then this new scoring model will have an immediate negative impact on the borrower's credit score by "shortening" the credit history.

This change is expected to have an especially dramatic - and negative - impact on teens and young adults who have been added by their parents as authorized users in an honest effort to help them establish credit.

One alternative to consider is making the borrower a joint cardholder instead of an authorized user, making each person equally responsible for the credit activity (payments and outstanding balance).

FICO is changing other scoring calculations as well. Points will be given for borrowers who have multiple types of credit (such as a mortgage, credit card and student loan). The thinking behind this is that borrowers who can manage various types of loans should be given greater consideration. Delinquencies also will be factored differently. The current scoring models lump in borrowers with one delinquent account with borrowers who are delinquent on multiple accounts. The new model separates these two groups.

When Good Payers Get Screwed

You are one of the "responsible" ones.

You have a few credit cards with decent rates. And you've always paid those bills on time.

So you don't think twice about that holiday discount offer - you know, the one where you can save an additional 10-15% on your purchase if you open up a department store credit card. Your credit is good - you are approved!

The next month, you get your credit card statements and fall out of your chair. Your credit card issuers have just raised your interest rates!

How could this happen when you've always paid your bills on time?

In yet another example of abusive credit card industry practices, big financial companies have adopted policies where they can bump up a consumer's interest rate for their credit card when their FICO score declines - even if they have never paid late on that card. Mind you, your FICO can decline when you do something as simple as open a department store credit card.

Members of Congress are currently investigating this and other abusive practices. The subcommittee found that in many cases, consumers have little notice of the increased rate, which are automatically triggered by declines in FICO scores "for reasons left unexplained."

Five big financial companies issue around 80% of credit cards in the U.S. -- Bank of America Corp., Capital One Financial Corp., Citigroup Inc., Discover Financial Services LLC, and JPMorgan Chase & Co.

One week prior to the Congressional subcommittee's hearing on the issue earlier this year, Citigroup suddenly announced that it would no longer make "any-time-for-any-reason" increases to interest rates and fees charged to customers, at least until a credit card expires and a new one is issued (usually in two years). JPMorgan Chase followed suit, saying they also will discontinue the practice.

But legislation may still be needed to get other companies to do the same - and at least mandate that credit card issuers give customers adequate notice (at least 45 days) of terms and rate increases in language that can be understood by a fifth-grader.