Credit bureaus are preparing to remove the secrecy over credit scores, the three-digit numbers that help lenders decide whether to lend money and at what interest rate.
As a result, you’ll be able to shop smarter for loans.
In some cases, you might find out that taking a simple step could boost your credit score enough to make an immediate difference in the loan rates you’re offered.
“It’s a major step forward,” says Edmund Mierzwinski, consumer program director for the U.S. Public Interest Research Group. “Giving consumers more information will help to balance the scales.”
The change will immediately benefit loan applicants who have better credit than they realize, and people pay who pay their debts on time, but who are unknowingly penalized for borrowing from the wrong lenders.
The nation’s big three credit bureaus — Equifax, Experian and TransUnion — compile your credit history and sell it to lenders, landlords and prospective employers.
Using a secret formula that’s as zealously guarded as the recipe for Coca-Cola, credit bureaus boil your credit history down to a number. The number — called a credit score — is usually somewhere between 300 and 900. The higher your score, the more likely you are to repay a debt as agreed.
How credit scores are used
Lenders use the scores to decide whether to lend money and on what terms.
For example, a mortgage broker might turn down anyone with a score below 550. It might loan money at a high interest rate for people scoring between 551 and 600, at a lower interest rate for people scoring between 601 and 640, and at the best interest rate for people scoring higher.
You can see why it would be handy to know your credit score. But for years the credit bureaus kept the scores secret. They forbade lenders from revealing the scores to loan applicants. Most lenders didn’t mind — it wasn’t in their interest for consumers to know their credit scores.
Then California stepped in with a law requiring credit bureaus to give out the scores to state residents applying for credit by July 1, 2001. And members of the U.S. Congress started talking about mandating a similar law nationwide. At least two credit bureaus — Equifax and TransUnion — are expected to provide credit scores to consumers beginning in the first half of 2001.
“Confused and misled”
A company called Fair, Isaac and Co. provides the credit score-generating formula to the credit bureaus. People in the industry often call the numbers FICO scores, after Fair, Isaac’s company name. For years, Fair, Isaac contended that consumers would just be confused and misled if they saw their credit scores without a detailed explanation of how the scores were calculated.
You might think that the solution would be to provide consumers with their scores and explanations. But Fair, Isaac didn’t want to explain how it calculated credit scores, for two reasons.
First, explaining scores might open the door to Fair, Isaac’s competitors.
Second, consumers might be able to use the information to manipulate their scores.
To which one lender replied: Yeah. So what? For a brief time last spring, online lender E-Loan allowed consumers to see their credit scores. When Fair, Isaac complained, Equifax stopped supplying E-Loan with credit reports. E-Loan relented, but at the same time the online lender lobbied Congress to require credit bureaus to release the scores to consumers.
“It’s the consumer’s data, and finally we’re seeing a break of this antiquated viewpoint that it’s OK to keep customers in the dark,” says Chris Larsen, CEO of E-Loan. “Information improves markets.”
Larsen believes that the availability of credit scores will bring a revolution because consumers will manage debt in the same objective way that asset managers oversee investments.
“We see our business as being the unbiased advisers to consumers — how to manage their overall debt portfolio,” Larsen says. “You can do debt management only if consumers have access to all the data that allows them to say, ‘I need to improve my credit-worthiness.’ Without credit scores, you can’t get out of the starting gate.”
Explanation of the “reasons”
When a credit bureau calculates your score, it is accompanied by “reason codes” that explain, essentially, why your score isn’t higher. The California law requires credit bureaus to tell consumers the top four reason codes.
“You can have a credit report where the ordinary person who looks at it can’t tell what’s wrong with it,” says Gail Hillebrand, senior attorney for Consumers Union in California. Reason codes will explain that you are being penalized because you are borrowing from a finance company rather than a bank, or because you have too few credit cards or too many credit cards or you have too many accounts with balances or too many accounts without balances.
You can even be penalized for paying for your car with cash, Hillebrand says. In that case, you’ll get a reason code that says you lack auto-loan information.
Hillebrand gives two examples of how consumers can use reason codes and credit scores to their benefit. She says that many department-store charge cards are backed by finance companies instead of banks — and too many accounts with finance companies can lower a consumer’s score. With this information, a borrower could cancel a few charge cards and raise the credit score in just a few weeks.
And she says that some borrowers — especially residents of poor neighborhoods — have good credit and don’t know it. With knowledge of their credit scores, they could apply for a low-interest loan from a bank instead of applying for high-interest loans from finance companies and payday lenders.
The credit score-interest rate link
Larsen believes that lenders will be forced by competition to reveal the link between interest rates and credit scores. And when consumers get that information, plus their reason codes, they’ll figure out exactly what they need to do to raise their scores to qualify for better rates. Maybe they would just need to cancel a department-store charge card, or catch up on a late payment, to raise the credit score enough to qualify for a better interest rate.
“The consumer needs to know, ‘If I do this, I will raise my credit score by 20 points and that will save me a half-point on my mortgage,'” Larsen says.
Larsen imagines the day when you’ll be able to log onto a Web site, see your credit score, click on the score, and see how that score was arrived at and how it could be improved.
“It’s all about trusting the consumer — whether they’ll manipulate the score to bad effect,” he says. “We think the consumer will manage it just as they manage their investment assets — for maximum return.”
Details being worked out
The credit bureaus are still trying to figure out how they’ll pass along credit scores to consumers. Faced with the California law that requires them to provide credit scores to residents of the most populous state, they apparently figure it would be best to provide credit scores nationwide.
TransUnion plans to provide consumers with its own version of a credit score, on a different scale than the 300-to-900 FICO score. It will be easier to understand than a FICO score, TransUnion spokesman Clark Walter says. When consumers buy a credit report from TransUnion for about $8, the credit bureau will provide consumers with the score and an explanation, and the credit bureau will provide a phone number to call with further questions.
QSpace.com, which sells credit reports online, recently began selling credit scores as part of an agreement with Equifax. The cost is $11.90 — $7.95 for the online credit report and $3.95 for the online credit score. The score is on the same 300-to-900 scale as the one that lenders see. QSpace.com provides the credit scores on Yahoo Finance, too.
Equifax has announced that it plans to provide credit scores on its Web site sometime before the end of March. The credit bureau says it will describe how credit scores are calculated and give pointers on improving credit scores.
Experian has not revealed whether it plans to provide credit scores to consumers outside of California.