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.

Get a CLUE About Your Insurance Score

A reader e-mailed me to voice her distress over her auto insurance rates. Prior to her divorce, she and her husband had been able to obtain reasonable rates for their two cars. But the divorce was messy. Their house fell into foreclosure as it languished in the stagnant real estate market. Bills that were supposed to be paid by her (now ex-) husband went into collections. Her credit score began dive. She eventually filed for bankruptcy. As things went from bad to worse, she was stunned to learn that her application for new auto insurance coverage was denied.

"I've never filed a claim or gotten a ticket for anything!" she wailed. "My husband and I always paid our insurance on time, and my driving record is totally clean!"

One thing that may have impacted her ability to get insurance for her car is her credit history and public records information. Insurance rates for homes and cars are often linked to credit scores. Insurers justify increased rates by relying on statistical analyses that purportedly show a correlation between an insured's credit history and likelihood of filing a claim.

This means if your credit file shows a history of late payments, foreclosure, tax liens, garnishments, bankruptcies, lawsuits and judgments, you may be smacked with high insurance rates or even be denied coverage.

This data - plus any information on claims you have filed (and sometimes even inquiries about your coverage that do NOT result in a claim) - is entered into a little-known database called CLUE (Comprehensive Loss Underwriting Exchange) or its smaller competitor, A-Plus. These national databases are used by insurers to determine whether you get new insurance. Insurers may also look at your claims history and "insurance score" when deciding whether to renew your coverage or how much to charge for your premiums. Because it is a national database, other insurance companies can review your claims history for five years. This may include losses for a property before you even owned it.

Some home buyers learned this the hard way, with deals falling through because of inquiries - not necessarily claims - that cause the property to be "blacklisted." The previous owner may have inquired about coverage for water damage; even though the owner may never have filed a claim, the information is posted into the database, and insurers will assume that there is a problem.

Consumer advocates have been pushing hard for reforms. As a result, some states have passed legislation to prohibit the inclusion of inquiries that did not result in a paid claim. Other states have begun passing laws to limit or prohibit the use of credit scores as the sole determining factor in deciding insurability or rates (see if your state has such laws); however, many insurance companies still rely on them to some degree.

Given the fact that 79% of credit reports contain errors, it may be concluded that rates may be artificially inflated or insurance unfairly denied when determined - in whole or in part - by credit history.

The good news is that this specialty report is governed by FCRA. Under the FACT act, you have the right to obtain a copy of your CLUE or A-Plus report each year, and the right to dispute inaccurate or incomplete information on those reports. If you have been denied coverage, had your policy cancelled or your premiums have increased, the insurer must notify you in writing; in addition, you are entitled to a free copy of your report (in addition to the free report you are allowed each year).

To get a copy of your CLUE report, visit ChoicePoint's Web site or call toll free: 1-866-312-8076. To get a copy of your A-Plus report, call toll free: 800-627-3487.

You will not get your actual insurance "score" - just the history of claims. Because your credit score is factored into whether you are insurable and what your rate will be, you should also purchase your credit score as well in order to get a complete picture of what your insurance company is seeing.

Thin is In with Experian's New Credit Scoring Tool

According the Federal Deposit Insurance Corp., there are nearly 73 million consumers in the United States with "thin" or no credit files – that is, they have little or no credit in their name. This segment of the population – typically students, young people, minorities, recent immigrants and those with low incomes – is traditionally underserved because lenders favor borrowers with more "meat" in their credit files, which allows them to better assess loan risks.

As a result, most "unscoreable" consumers pay bills and make purchases using cash, checks or debit cards – none of which is tracked by credit reporting agencies. And as the housing market continues to implode, more people will continue to rent instead of purchase, which means they won't have an established mortgage loan history for lenders to evaluate.

With profit margins eroding, financial institutions are looking to create new revenue opportunities by tapping into the billions of dollars in annual income represented by this currently underserved population.

Experian has launched a new credit scoring tool called Emerging Credit Score to help lenders "capitalize on missed opportunities" to "create new revenue opportunities" by factoring more than 25,000 attributes to measure thin or no-file consumers. It uses data from eBureau to track:

• Demographics
• Internet, catalog and direct-marketing purchases and payments
• Trades, inquiries and public records
• Property and asset records
• Telecommunications and utility data
• Industry specific and custom scores

Do Lenders Really Care?

While innovative ways of creating credit scores appear to be a boon for thin- or no-file consumers and financial institutions alike, the difficulty lies in having such scoring tools adopted by the banking industry. There already are a number of scoring models that purport to open the doors to this target population, including FICO's Expansion Score (released in 2004) and PBRC. Until banks use these tools on a regular basis to evaluate their prospects – something that has not been done industry-wide – the underserved population will not see much of a change. And if you have a traditional credit score from the Big 3, an expansion score will not be used in its place, which may seem particularly unfair if your credit history is rife with errors due to reporting mistakes or identity theft.

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.

A Credit Check for the Lunch Lady

Current and prospective school employees in Bentonville, Arkansas, may soon find their credit histories under the spotlight if a proposed policy requiring every district employee or applicant who handles money or uses a credit card to consent to a personal credit check is passed.

That includes everyone from top executives managing the district's budget to the cafeteria manager to "department heads who reserve conference and hotel rooms with district credit cards, bookkeepers, all employees who process paychecks and perhaps even district employees who volunteer in their off-hours to work at school concession stands."

It's becoming more common for employers to run credit checks on prospective employees. There is the belief that a person's credit history can indicate how he or she handles money, which translates into how he or she would handle the company's money. In this situation, the policy would also apply to existing employees.

But credit scores can be negatively impacted in a number of ways that may not necessarily show willingness or ability to pay, or indicate that the person would misuse their position to steal or embezzle funds. If they recently applied for credit, if they have fully paid off an old collection account, if they are young and haven't established a lengthy credit history, or if they use a credit card from a company that doesn't report their actual credit limit, their score will be lower. Identity theft victims may not even be aware that their credit file has been hijacked until an employer runs a check.

According to The Morning News, committee members questioned whether someone with an unfavorable credit score still could be hired or allowed to continue working for the district. Steve Potts, the executive director of Human Resources, confirmed that credit scores would be part of the hiring process and would also be considered when allowing an employee to continue in a job.

Superintendent Gary Compton stated he believed that by conducting credit checks, administrators might more easily spot mishandling of taxpayer money, or those prone to do so.

But your Credit Mama believes that credit scores are an increasingly unreliable predictor of future performance - that is clearly apparent with the current subprime meltdown. Eight out of 10 credit reports contain errors. Imagine if your work product was only correct 20% of the time! Yet our society is using this seriously flawed data to make major decisions that impact our lives.

The Bentonville School Board Policy Committee is due to review this measure at next month's meeting.

650,000 Affected in Latest Credit Data Breach

In yet another case of sensitive data becoming MIA (missing in action), the personal information of 650,000 people, including names, addresses, account numbers, Social Security numbers, and other information, was comprised when GE Money Americas and its backup storage vendor, Iron Mountain, lost an unencryted backup tape.

The backup tape contained data on customers for JC Penney and up to 100 other retail store customers.

GE Money alerted the New Hampshire Attorney General's office of this security breach on Dec. 28, 2007. According to their notice, the tape was checked into Iron Mountain's secure facility and never checked out, but a search of Iron Mountain's premises and theirs has been unable to locate it.

It is hard to assess if the information on the missing tape is being used inappropriately or whether it will be misused in the future. GE Money is offering 12 months of credit monitoring for those persons that had Social Security numbers on the lost tape.

As anyone familiar with the TJ Maxx data breach knows, 12 months is a short blip in the lifespan of sensitive personal data like Social Security numbers. It becomes the consumer's burden to regularly and consistently check his or her credit report for possible identity theft issues. If you fear that your personal identifiable information has been compromised, you can elect to implement a "freeze" on your credit.

To contact GE Money, call toll-free Monday through Friday, 9:00 am to 7:00 pm EST, at 1-866-913-6690.

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.