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Credit scores: what they aren’t

July 15, 2011

Last week I wrote about what a FICO credit score is and how it is used by banks to make decisions about whether and on what terms to lend to a consumer.  This week I’d like to write about two legal issues that the credit score system can present.

The first legal issue with using FICO credit scores to make lending decisions is that it makes credit reports incredibly important to consumers.  Because the FICO score is derived from an Experian, Equifax, or Trans Union report about a consumer, the consumer will want to be sure the report is accurate so that the score is, too.   If a consumer met with a bank officer, the consumer could look at the credit report along with the bank officer and point out any errors before the officer made his or her decision to lend.  Because most lending decisions are now automated, it is very important for consumers to have accurate credit reports when they apply for credit.  The fact that some credit reports aren’t accurate is what drives a great deal of FCRA litigation:  consumers will allege that an inaccurate report prevented them from getting a mortgage on a dream house, or caused them to pay exorbitant interest rates.

The second legal issue involving the credit score system is that it makes consumers want to know their credit score in advance.  Consumers who know their credit scores can predict (to some extent) whether they will get credit before they apply for it.  Consumers can also try to improve their scores (by improving their credit history) before applying for new credit.

And here, we run into a quirky sub-issue:  most lenders use the FICO credit score created by Fair Issac & Co. to make lending decisions, but consumers who want to know their credit score before applying for credit may or may not see that FICO score.  After they noticed the attention that FICO was getting (and the money it was making) for its credit scores, Experian, Equifax, and Trans Union decided to get in on the act by creating their own credit scores.  Each of these three bureaus now uses its own algorithms to look at its own raw credit data and to create a score, and they also have a joint product called VantageScore that uses algorithms to create a different score based on all three bureaus’ collective data.  These scores will differ from the FICO score in that:  1) they have different algorithms; and 2) they have different scales.  For example, the FICO scale is 300-850, but the Experian scale is 330-830, and the VantageScore scale is 501-990.

The existence of multiple credit scores means that a consumer who is planning to apply for a loan may decide to check her credit score through Experian, in which case she will likely get an Experian score on the Experian scale.  However, when that consumer applies for credit, the bank might decide to pull raw data from Trans Union and get a FICO score based on that data.  The bank will therefore be using different data and a different score than the consumer anticipated.

In short, credit scores that consumers obtain from the three credit bureaus aren’t necessarily the credit scores that a bank will use in deciding whether and how to extend them credit.  A smart consumer will know this and plan accordingly, by (for example) obtaining 3 FICO scores in advance (one using each bureau’s data), asking a bank which score it uses, or just ignoring scores altogether and focusing instead on whether the raw credit data on each bureau’s report is accurate.

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  1. August 24, 2012 at 10:06 am
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