Chapter 3: Credit Scores – What’s the BFD?
Credit Scoring: An Overview
What is a Credit Score? Why is it important? To whom is it important? Do I need to know it? How do I get it? What is the big frickin’ deal?
Before we delve into a logical and methodical, educator-approved, clearly delineated, properly headed and sub-headed chapter on credit scores and credit history, I’m going ignore convention and jump right in the middle of this messy content puddle by saying:
Your Credit Score is very important; so important that over a lifetime it could significantly impact your finances and financial quality-of-life.
However… a person could go a lifetime and never need to know their score!
Confused? I hear you.
Think of it this way: your heart is important. Monitoring your heart
and working to keep it healthy are worthwhile endeavors but
you don’t need to actually see your heart to measure its health, right?
Same goes for your Credit Score.
As clear as mud, I know.
Before we untangle this subject and answer all of the burning questions above, how about a quick history lesson?
The History of the Credit Score
Imagine, if you will, the golden age of mathematics and engineering. It’s the mid-1950s. Can’t you just picture the white button-down shirts, black suits, skinny ties, and horn-rimmed glasses? In the ten years since the end of WWII, the American economy has boomed. And so has the population. People have been busy making things and buying things and selling things. The business of consumer credit is beginning to explode, fueled in part by the unquenchable demand for products being hawked by new, more sophisticated ad men.
In 1956, two men — Bill Fair, an engineer, and Earl Isaac, a mathematician — founded a company dedicated to quantifying the creditworthiness of consumers for the benefit of the business world. In plain English, Fair and Isaac created a number scale that, on the low end, indicated a big credit risk and on the high end, a low credit risk. They also developed a mathematical formula that could be used to estimate where a person would fall on that credit risk scale.
Their company, originally named Fair, Isaac and Company, is now known as FICO®.
FICO® is perhaps the best known provider of credit scoring. It is a publicly traded analytics software company. They use “Big Data and mathematical algorithms to predict consumer behavior” and help businesses across the world “make better decisions that drive higher levels of growth, profitability, and customer satisfaction.”2 In other words, FICO® is a huge, profit-driven company that collects data about consumers (you), quantifies that data (turns it into a number), and sells it to other profit-driven companies who want to profit off of you.
Their website claims that 95% of the largest U.S. financial institutions are FICO® clients, 100 billion FICO® scores have been sold to date, and three-quarters of the mortgages granted to home buyers are based, in part, on FICO® scores.
And, yes, you read that last sentence correctly: “100 billion FICO® scores have been sold.”
The reason for this history lesson is that I want to emphasize a point: You are the product.
Credit Scores Today
The deep irony of credit scores is that not only are you the product but you have also become the consumer.
If you know anything about business and marketing you know that the key to growth is finding new markets (new people to sell to). What better way to make a profit than to sell an existing product (one you already make) to a whole new group of people?
And that’s how credit scores came to be one of the hottest, latest-and-greatest must-have products on the market. Somehow, somewhere someone came up with the brilliant marketing strategy of taking a relatively obscure product sold only to industry-insiders, repackaging it, and selling it to a massive new market: the public.
Naturally, as soon as a lucrative new market is tapped, the rush is on for everyone to grab a piece of the action. Today, it seems, everyone wants to sell you your credit score. Or give it to you as part of a promotion when you buy another product. Is there anyone who isn’t inundated with offers for shiny new credit cards that come with the promise of free credit score monitoring to cardholders?
Okay, how about a quick inventory of what we know so far?
- Credit scores are important (but you’re still just taking my word for that right now).
- Two guys, Fair and Isaac, developed a mathematical model to predict the creditworthiness of everyday consumers and then invented a credit score scale for interpreting the scores. Low is bad; high is good.
- These guys then start selling people’s scores to the companies that provide loans to consumers.
- Then someone comes up with the brilliant idea of selling estimates of consumers’ creditworthiness back to the customers themselves.
Remember when I mentioned clever marketing? Taking an existing product and “repackaging it?”
Yeah, well, bad news. Your credit score has been repackaged.
Credit scoring companies sell slightly different versions of their scores to different industry customers. Now there’s nothing inherently nefarious going on when they do this. It’s quite common for credit scorers to use different algorithms tailored to fit the questions that one industry considers more important than another industry does.
Take the mortgage loan industry, for instance. Mortgage lenders want to know specific things about your credit history and credit behavior. They are interested in whether you pay your bills on time but they also want to know how much consumer debt you have (how much of your monthly income is tied up in credit card payments). On top of that, though, mortgage lenders are particularly interested in how much unused consumer credit you have—how much debt you could rack up on your credit cards.
Let’s talk about my daughter again for a minute. She’s tired of paying rent and has decided that her goal is to buy a house in the next few years. So, she’s focused on saving money for a down payment and doing some research on neighborhoods, etc. Her credit is very good so that’s not one of the issues she’s been thinking about.
A few weeks ago she texted me about an ad she’d gotten from her bank offering her a $200 cash bonus for opening a new credit card. All other pros and cons to a new credit card aside, I pointed out that opening a new credit card right now could negatively impact her credit score in the eyes of potential mortgage lenders.
And here’s why: credit card companies (representing a different industry) don’t care that you have multiple cards and they don’t worry much about the total credit available to you (how much total debt you could rack up on your cards). But mortgage lenders do care. In fact, they care a great deal. They see it as a major turnoff if, in your desire to get your new home on the cover of House & Garden, you could potentially go out and rack up $75,000 in debt on your existing credit cards.
All lenders share concerns about the same general credit information but separate industries care a little more about some facts and a little less about others. So, credit scoring companies have created different algorithms giving more or less weight to factors that matter to each industry. Mortgage lenders are particularly interested in how much you earn, what your fixed expenses are, and how much unused credit you have access to across all of your credit cards. Auto lenders are particularly interested in whether you have a steady, secure source of income and if you pay your bills on time.
So how does that relate to how credit scores are repackaged for consumers? Well, we consumers get what are referred to as “educational” scores—a euphemistic term for scale-modeled credit scores that credit scoring companies sell directly to the public. These are the “lite” version of credit scores; the “display purposes only” version similar to the fake TV monitors IKEA uses to sell TV stands.
I’m going to leave you to draw your own conclusions as to why consumers, as an “industry,” get the “display purposes only” version. Personally, I can’t help but feel that we get what we deserve.
The point is, unless you’re an industry insider, when you see your credit score—whether as a perk of one of your credit card accounts or you paid for it from any of the multitude of online services, you’re seeing an educational score, not an industry score. If you walk into an auto dealer and you’re armed with your piece of paper with your credit score and you wave it around under the lender’s nose saying, “see, I’ve got the same information you do so don’t try messing with this customer!”—understand that the loan officer has a real TV with a power plug and everything and you, well, you’ve got a “for display purposes only” IKEA TV.
So, here’s the takeaway:
As much as the banks and the merchants and the credit scoring companies try to frame credit scores and our credit reports as products that we, consumers, consume (use),
that tale is nothing more than a clever advertising tactic.
Consumers are the product (what is being offered for sale); merchants and advertisers and corporations are the consumers (the ones buying the product);
and the financial industry players are the producers (the ones raking in the profits).
But before we put a cap on Credit Scores and send them off completely, let’s get really real with each other.
You know you’re the product and it makes no logical sense to also be the consumer. You also know that the product you’re buying is the educational version of your score. But, it’s human nature to be curious, isn’t it? I understand. Really, I get it.
So, if you really can’t resist the temptation, your best option, if it’s available to you, would be to access your credit score through a credit card you already own. For one, it’s free. More importantly, the credit card company already knows everything there is to know about you — your name, your social security number, your address, where you shop, and how much you spend. When you sign up to accept their offer of providing your score for free, you’re not violating your own privacy beyond what is already violated.
If that’s not an option, your second-best option would be to get your score from one of the three big reporting agencies (Equifax, Experian, or TransUnion). [We’ll cover this in detail next in Section 3.2 – Credit History & Reports.] Although you have to pay a fee to get your score, the reporting agencies, like your credit card companies, know just about everything about you except what you ate for breakfast. And for all I know, maybe they even know that, too. The point is that by going to a source that already has unfettered access to all of your credit data you’re not further allowing your privacy to be invaded. You’re not agreeing to share your data with a whole new source.
What I strongly advise against is using any of the growing number of sites online hawking your credit score. Even for “free.” The reason being that the cost of paying for an “educational” score from a site that already knows all of your data is much, much cheaper in terms of your privacy than getting a “free” score in exchange for signing over your privacy rights to a 3rd party vendor.
And that, my fine friends, is the end of Credit Scores: What’s the BFD? I hope you feel like you have a better understanding of why those pesky scores are both Big and F**king deals.
Next up, I think it’s about time we go back to our regularly scheduled methodical, organized, neatly headed and sub-headed lesson on Credit History, Reports, and Scores.
“About Us,” FICO, Fair Isaac Corporation, accessed November 20, 2017, http://www.fico.com/en/about-us.