New Developments in Credit, Debt, and Credit Scoring

Free Credit Scores for Rejected Credit or Job Applicants

Starting in July 21, 2011, the Dodd-Frank Act requires that lenders must give loan or job applicants — who were turned down for a loan or a job or who got lower interest rates because of a credit score — the credit score that the lender or employer used in its decision. Although most borrowers have at least 3 credit scores based on credit reports by the 3 major credit reporting agencies, only the credit scores that were used in the lending or hiring decision are required to be given.

Estimated Income May Now Be Added to a Consumer's Credit File

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Source: Look Who's Peeking at Your Paycheck

1/13/2010 - Beginning in February, 2010, the credit bureaus will make available their estimate of your income, based on a statistical analysis of various databases. The Federal Reserve has issued final rules that requires credit card issuers to consider the credit applicant's current income or assets or current debt before issuing credit. Mortgage borrowers will need to supply income tax information or fill out IRS Form 4506-T, Request for Transcript of Tax Return that allows the IRS to release income data to the lender.

The income estimates by the credit reporting agencies Experian and TransUnion are also being used by collection agencies to decide which accounts would more likely to yield a payoff. Experian's statistical model estimates income to the nearest thousand, while TransUnion offers a range. However, a TransUnion employee estimated that it is not uncommon for income estimates to be off by $15,000 to $20,000.

Because the income estimates are inexact, the contracts that the reporting agencies have with lenders prohibits lenders from basing their credit decision solely on the income estimate, though it may prompt lenders to get more information from you.

Any buyer of credit information, such as lenders and debt collectors, may get this information without your consent as long as they are using the information for legitimate purposes. No more liar loans!

New Additional Criteria for Credit Scoring - Behavioral Scores and Mortgage Holders

Source: AmEx rates credit risk by where you live, shop

10/7/2008 - According to this article, American Express is going beyond credit reports and credit scores to evaluate the creditworthiness of its cardholders by using data on where you live, where you shop, and who your mortgage lender is to gauge your creditworthiness. The predictive value of these additional criteria are measured by the creditworthiness of all people shopping at particular locations or living in particular areas, or by who holds the cardholder's mortgage, and then modifying the traditional credit criteria by these findings, which often results in reduced credit limits or even in the closing of accounts. American Express is referring to its location criteria as a property risk model, and says that the factors that influence that model changes frequently. However, what is purchased is not a risk factor.

Previously, American Express raised credit limits for 80% of its cardholders while lowering the limits on 20%. Using the new credit scoring, or what may be called behavioral scoring, the ratio is now 50%/50%. As an example, those who shop at rent-to-own stores will raise red flags, since people tend to shop at these stores when they are overextended or cannot control their impulse to spend. Because their prices are much higher than at regular stores, shopping at rent-to-own stores is considered indicative of poor money management or poor impulse control.

As for mortgages, a spokesperson for American Express said that only the identity of the mortgage holder matters—it makes no difference if the mortgage holder was an originating lender, or if the loan was purchased in the secondary market. The borrower, of course, has no control over the sale of his loan in the secondary market, so there could be marks against the borrower even if the originating lender is not a subprime lender.

FICO 08

Fair Isaac has altered its FICO scoring model, calling it FICO 08, to hopefully better predict consumer defaults. FICO 08 will continue to have a range 350 - 800, and it will still rely heavily on the amount of debt and payment history. However, FICO 08 will no longer use authorized user accounts in calculating the score. More positive weight will be given to users who have multiple types of credit, such as auto loans and mortgages, in addition to credit card history, while the debt-to-credit ratio—the total debt compared to a user's total credit line—will be given greater weighting—a higher debt-to-credit ratio will have a more negative effect that it did in the classical FICO scoring model. Numerous late payments will also have a more negative impact, while an occasional late payment will have less impact than in Classic FICO. FICO 08 scores should start appearing in the 2nd quarter of 2008. Experian and TransUnion will be using the scoring system, but it is uncertain at this time whether Equifax will be using it.

Credit Freeze for All

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(October, 2007) Many cases of identity theft rely on stolen social security numbers, which are then used to open credit accounts, often with high balances. The thieves max out the credit lines without any intention of paying back the loans, which leaves the people with those social security numbers on the hook. The identity theft victims then must go through the travails of convincing credit bureaus and creditors that it was not them who took out the lines of credit, and that they were the victims of identity theft.

A credit freeze, which stops the credit bureaus from issuing credit reports to potential creditors, prevents the thieves from getting any more credit with that person's identity, since almost all creditors require a credit report before they will issue credit or pay out loans. The disadvantage is that the victim of identity theft also cannot get any more credit until he unfreezes his account.

39 states have various laws that allowed consumers to freeze their credit reports, at least to some extent, but now that the credit bureaus see the growing trend, and also see the potential profits to be made by allowing consumers to freeze and unfreeze their credit reports for a fee, all 3 have decided to allow it regardless of where the consumers live. TransUnion was the 1st, while Equifax and Experian will allow it soon—Experian on November 1, 2007. The current fee is $10 to freeze it and $10 to unfreeze it, for each report, except in those states that require a lower fee, and it is free for any victims of identity theft. Therefore, a consumer who is not a victim of identity theft will have to spend $60 to freeze and unfreeze all 3 credit reports. The freeze request can be made by mail, telephone, or email.

Piggybacking Will No Longer Raise FICO Credit Scores

(6/18/2007) According to this New York Times article, Ron Totaro, vice president for global scoring solutions at Fair Isaac, has indicated that, starting in September, the FICO scoring algorithm will no longer include authorized user accounts in its formula for calculating FICO scores.

Credit-Freeze Laws

(11/4/2006) Many states are enacting laws, to prevent identity theft, that allow consumers to freeze access to their credit reports without their explicit authorization, which extends to almost any anyone wanting access to someone else's credit report, including credit card and cell phone companies, although consumers may have to pay a fee ranging from $5 to $20 to each credit reporting agency that issues a credit report, and another charge to unfreeze it, which can take up to 3 business days.

Half of the states have passed or are considering passing credit-freeze laws. Kansas, New York, Oklahoma, Utah, and Wisconsin have recently enacted credit-freeze laws. California was the first, but some portions of its law have been struck down by an appeals court, which affects only California, but challenges are likely elsewhere, as more states pass it, and enough time passes to mount challenges. 5 states allow only identity-theft victims to freeze access to their reports, and some states allow victims to freeze their accounts without paying a fee.

The big disadvantage for the consumer is that credit and other services that depend on credit checks may be more difficult and time-consuming to get.

Naturally, the finance and retail businesses oppose credit-freeze laws because of the burden on them. They argue that a consumer can place free, 90-day fraud alerts on their credit file, which requires the business requesting a credit report to verify the identity of the consumer. However, consumer advocates argue that fraud alerts are rarely effective.

New Methods of Assessing Creditworthiness

Banks and other credit card issuers are using additional information in assessing the creditworthiness of their customers. While all of them use credit scores, some are searching for additional information on their customers to try to forestall credit problems in these hard times.

Some of the criteria being used as a basis for lowering credit limits or maybe even canceling accounts include home prices in the customers' neighborhoods, the type of mortgage lender being used, and where they shop. According to this New York Times article, American Express Kept a (Very) Watchful Eye on Charges, American Express was even using spending patterns as a additional means to gauging credit risk of its current customers. American Express was evidently compiling a list of merchants who had more than an average share of customers that later had credit problems, then looked for customers who frequently shopped at those sites, causing American Express to re-assess their creditworthiness in light of the other information. American Express stated that it has stopped using shopping criteria for credit scoring, and that its main criteria is the overall debt load of the customer compared to their financial resources. It has also told analysts recently that people with multiple mortgages on multiple residences use to be a good credit sign—now it is considered a red flag. American Express does consider mortgage lenders, which they can learn about from their customers' credit reports, and that credit lines may be affected if the mortgage lender is a subprime lender or if it went bankrupt. Another area being examined for its small business customers is the type of business that the customer is involved in—credit limits may be lowered or even credit denied if it is a type of business that will probably be adversely affected by the current downturn, such as home construction or finance.

Citigroup has stated that it is using some mortgage data, but does not consider specific stores being shopped by customers or the type of merchandise being purchased. Capital One stated that geography is considered, but not spending patterns.

In 2008, CompuCredit, a subprime lender, was cited by the Federal Trade Commission for failing to disclose that customers' credit lines could be lowered if they shopped at particular types of merchants that would indicate that either the customer was under financial stress, such as marriage counselors and repair shops, or that customers did not spend their money wisely, such as bars and nightclubs, pool halls, pawnshops, and massage parlors—although one may find a good bargain at a pawnshop.

Raising Credit Cards Rates even without Changes in Credit Score

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The article below details the raising of interest rates on credit cards substantially, in many cases, to more than 25% by Bank of America, even for consumers who paid on time and whose credit score has not changed.

This underscores several important points about getting into deep credit card debt.

  1. Banks can raise rates at any time. You can avoid paying higher rates by writing the company before the specified time informing them you do not agree to the rate increase. In most cases, you will not be able to use the card until the loan is paid off, but at least the loan will only accrue interest at the old rate.
  2. Banks can lower limits on credit cards at any time, which reduces the debt to credit limit ratios used by algorithms that calculate credit scores, which lowers consumer credit scores, which will generally increase borrowing costs for the affected consumers.

These considerations also underscore why you should have a savings account for financial emergencies rather than depending on credit cards, because you never know when your limits will be reduced.

A Credit Card You Want to Toss

Corporate Credit Cards, Credit Reports, and Credit Scores

Corporate credit cards are often issued so that an employee can pay and track expenses, and the bill must be paid in full, so there is no accumulation of interest. With a corporate credit card program, either the company takes responsibility for timely payments, or assigns that responsibility to the employee.

If the company takes responsibility, it will generally pay the bill after the employee files an expense report; otherwise, the employee pays the bill.

When the corporation is responsible, then an employee's credit record and credit score will not be hurt if the payment is late. Even when the employee is responsible—43% of the time according to 1 survey—the credit card companies may give the employee an extended grace period. American Express, the major corporate card issuer, won't report the delinquency for at least 180 days past the due date.

However, late payments can result in loss of rewards or require the payment of a fee to reinstate the rewards, or require payment of late, suspension, or reinstatement fees. It may also hurt the employee's relationship with the company, since it not only indicates that the employee isn't very responsible—a quality needed for most jobs—but the company may get less of a refund from the credit card company because of higher delinquency rates.

Green Thumb - WSJ.com