Credit Score

Credit Scoring’s Unfairness

Developers of credit scoring point out their fonnulas are designed not to discriminate. Credit scores don’t factor in your income, race, religion, etlmic background, or anything else that’s not on your credit report. But it’s not clear if the result of those fonnulas actually is nondiscrimi- natory. Some consumer advocates worry that some disadvantaged groups might suffer disproportionately as a result of credit scoring. Among their theories: People who have low incomes or who live in some minority neighborhoods might have less access to mainstream lenders and thus have worse credit scores. The lenders these disadvantaged populations do use-finance companies, subprime lenders, and community groups-might not report to credit bureaus, making it harder to build a credit history. If these lenders do report to the bureaus, their accounts might count for less in the credit-scoring formula than those of mainstream lenders. Seasonal work is also more prevalent in some neighborhoods, which can lead to a higher rate of late payments in the off-seasons. Even if credit scoring doesn’t discriminate against groups, it might dis- criminate against you.

No credit-scoring system is perfect. Lenders know that their formulas will reject a certain number of people who actually would have paid their bills. Another group will be accepted as good risks, but then default. If these groups get too large, the lender has trouble. When too many bad applicants are accepted, the lender’s profits plunge. When too many good applicants are rejected, the lender’s competitors can scoop them up and make more money. But lenders accept a certain number of misclassified applicants as a cost of doing business. That’s little comfort to you, if you’re one of the responsible ones who loses out on the mortgage you need to buy a home, or if you end up paying more for it.

It was in the course of those conversations that an increasing number of consumers starting hearing about FICOS and credit scores. For the first time, people learned that the reason they did or didn’t get the loan they wanted was because of a three-digit number. It became obvious that lenders were putting a lot of stock in these mysterious scores. But when consumers tried asking for more details, they often hit a brick wall. Fair Isaac, the leader in the credit-scoring world, wanted to keep the information secret. The company said it worried that consumers wouldn’t understand the nuances of credit scoring, or they would try to “game the system” if they knew more. Fair Isaac feared that its formulas would lose their predictive ability if consumers started changing their behavior to boost their scores.

Now, some sympathetic mortgage officials didn’t buy into Fair Isaac’s company line. They thought consumers deserved to know their score, and these officials also often tried to explain how the numbers were created. Unfortunately, because Fair Isaac wouldn’t disclose the formula details, a lot of these explanations were dead wrong. Even more unfortunately, some loan officers perpetuate these myths about credit scoring, despite the fact that we have much more information about what goes into them.

Resentment about the secret nature of credit scores came to a head in early 2000. That’s when one of the then-new breed of Intemet lenders, E-Loan, defied Fair Isaac by letting consumers view their FICO credit scores. For about a month, people could actually take a peak at their scores online and learn some rudimentary information about what the numbers meant. Some 25,000 consumers took advantage of the free service before E-Loan’s source for credit-scoring information was cut off. But the proverbial cat was out of the bag. A few months later, with con- sumer advocates demanding disclosure and lawmakers drafting legislation requiring it, Fair Isaac caved. It posted the 22 factors affecting a credit score on its Web site, grouped into the five categories you’ll read about in the next chapter. Shortly after that, the company partnered with credit bureau Equifax to provide consumers with their credit scores and reports for a $12.95 fee. In late 2003, Congress finally got around to passing a law that gave people a right to see their scores. By the time this update to the Fair Credit Reporting Act was signed into law, though, access to credit scores was almost old hat.