The future of FICO
this. You're thinking about refinancing your mortgage, but you know your credit
could use a bit of buffing.
So, you start doing all the things that the financial
wizards say you should. You pay off a couple of credit cards with balances and
close a couple of others that you don't really use. Not too much later, you
get an e-mail telling you that your credit score is now high enough to qualify
for the best interest rates.
Or, try this: Same scenario, but you're not sure
which activities will help your credit score and which ones will hurt. So you
pull up a credit score simulator and play with the variables to see how high
you can boost your score if you pay off all your balances, or if it's enough
to pay off just one.
Credit scoring is getting smarter, and friendlier,
for most consumers to use. The second scenario is already available from a variety
of companies, including Fair Isaac Corporation, the creator of the FICO score.
By way of introduction, credit scores are widely
used in the financial industry. The three-digit number is the result of a mathematical
algorithm. It's designed to help banks, credit card providers, auto loan companies
and others decide how good a credit risk you are, and it can make a tremendous
difference in the interest rate you'll be offered.
Derived by comparing your credit history and payment behavior
with thousands of other borrowers, the scores generally fall in the range of
500 to 850. The higher the number, the better. According to Fair Isaac Corporation,
a person with a FICO score of 720 or more will pay significantly less in interest
on a mortgage than someone whose score is below 560.
Your financial shadow
The mortgage industry has used credit scores for years to help speed up
the lending process. They're also widely used for car loans and are the driving
force behind online, "instant" credit card approval.
Plus, they've become standard in the insurance industry for setting
rates for car insurance. Employers use them to screen applicants, particularly
those for money-handling positions. Landlords access them for potential tenants
to see who's most likely to pay their rent on time.
And, of course, since credit scores aren't a deep dark secret
to be kept from consumers at all cost, just about everyone is offering consumers
the chance to buy them.
With so many companies offering their own version of credit scores,
it's no surprise that Fair Isaac Corporation has a "certified score."
The idea is that consumers can go to the company's Web site, purchase a current,
official FICO score and "use that as a bargaining lever with lenders to
get lower rates," Watts says.
Assistant Professor Mark Oleson, director of the Office for Financial
Success at the University of Missouri and a licensed marriage and family therapist
says that while he's read about financial institutions and insurance companies
using credit scores more often, there appears to be a lack of empirical evidence
to back up the claims that they're accurate predictors of other kinds of behavior.
"You can make a rational justification, but I haven't seen
much proof," he says.
Still, it makes sense to him to expand the use of credit scores
to such areas as employment screening.
"It is uncommon to counsel individuals with financial problems
who don't have other kinds of problems," he says. "You're more likely
to miss days at work, be less productive on the job, as well as have marriage
and other relationship problems if you are struggling financially. It makes
sense that if you have a low credit score that you are more likely to have problems
in other areas of life.
Employers looking to screen a large number of applicants could
easily see a credit score as an effective way to narrow the field, Oleson says.
"If I'm looking to hire someone and 50 people look exactly
the same on paper, I can filter through applications and see who has that extra
baggage," he says. "It seems like money management is an easy way
to filter people. There's this line drawn for people who do it well or don't
do it at all."
The biggest problem, of course, is the elimination of the human
side of the decision-making process, Oleson says. Two people side by side could
have the same $5,000 in credit card debt. But one of them could have run up
the bill on a Spring Break bender while the other is a single parent who got
laid off and used credit cards to feed her child.
Customized credit scoring
One trend in the use of credit scores that consumers should pay attention
to is the tendency of lending institutions to overlay their own underwriting
criteria on top of the score. The result is that a score will mean different
things to different lenders. A score of 680 might be seen as average to one
lender, but as quite good to another. The bottom line: If you don't like what
you're hearing from one lender or credit card, go shopping.
Of course, every system has its pluses and minuses. As Oleson
notes, if you have good credit, the system makes things easier for you. If you
have poor credit, it can be a barrier to getting a break.
Harvey Warren, co-founder of the Coalition
for Economic and Social Research, says that while credit scoring is a better
system than the "financial chaos" of having no predictive model, he
has serious concerns about them.
The problem, he says, is that while mortgage applications still
get a good deal of personal attention, many other credit issuers don't look
at anything except the score before giving an approval, particularly since a
lower score translates into a higher interest rate. He sees a correlation between
their burgeoning use and the record-breaking levels of consumer debt.
"When a guy calls me and says he has $850,000 in credit card
debt on 61 cards, does [the system] work?" he says. "Is it a good
system? Bankruptcies are at an all-time high . . . Maybe the people who do the
card issuing and marketing and checking aren't up to the task."
Leslie Hunt contributed to
-- Updated: Oct. 17, 2005