New Developments in Credit, Debt, and Credit Scoring
Recent Changes to What Is Reported in Consumer Credit Reports
A number of changes are being made in how medical debts are being reported in consumer credit files, which covers more than 200 million people in the United States.
The 3 major credit reporting agencies — Equifax, Experian, and TransUnion — will remove medical debt paid after being sent to collections. Under the old rules, even paid-off medical debt would remain in consumer credit reports for at least 7 years. However, under a 2015 settlement with some state attorneys general, the agencies had to wait 6 months before adding medical debts to consumer files and these debts must be removed if they are paid off by insurance companies.
New unpaid medical debts will not be added to consumer credit reports until at least 1 year after being sent to collections. Unpaid medical debts below $500 will also be removed in the 1st half of 2023.
The Consumer Financial Protection Bureau estimates that 43 million credit reports have more than $88 billion of medical debt. Research by the CFPB indicates that failure to pay medical debt is less predictive of future creditworthiness.
Other recent changes in what is reported in consumer credit reports includes the elimination of unpaid library fines, traffic tickets, and gym memberships and the removal, starting in 2017, of tax liens and civil judgments, from consumer credit reports.
FICO Resilience Index
FICO has come out with a new metric that they call the FICO Resilience Index which, when paired with the FICO score, presumably better forecasts future delinquencies when the economy falters. It presumes to measure people’s resilience or sensitivity to economic downturns. FICO developed this index so that lenders and creditors may continue to lend to those people who will be likely to withstand the economic downturns, thus allowing greater profits than would otherwise occur if the lender reduced their credit risk by increasing the credit scores necessary to obtain new loans or new credit or by lowering credit limits on existing accounts.
The FICO Resilience Index ranges from 1 to 99, and unlike the FICO credit scores or other credit scores, lower numbers indicate lower credit risk. So someone with a score of 10 is more likely to continue paying their bills as compared to someone with a score of 50 or 90. This index score is being used to rank consumers according to the likelihood of their default under economic stress, especially for people with average credit scores, which is why this new metric is being characterized as an index. FICO has broken the score down into 4 ranges with different degrees of resilience or sensitivity to economic changes:
- 1 – 44: Most resilient
- 45 – 59: Resilient
- 60 – 69: Sensitive
- 70 – 99: Most sensitive
The FICO Resilience Index score places a greater weighting on the total amount of debt and the number of open accounts. This index score improves as either of these quantities declines. Specifically, this index is based on the following factors:
- total balances on revolving credit compared to the credit limits;
- the number of open active credit accounts;
- the number of hard inquiries within the last 12 months;
- the length of the credit history, with longer histories being much better.
Lower numbers for the 1st 3 factors and a longer credit history yields a better score. This scoring algorithm places the greatest weighting on the credit utilization, which is the total amount of debt on each line of credit compared to their credit limits. Note that having more open active credit accounts increases your FICO Credit Score, indicating lower credit risk, but also increases your FICO Resilience Index score, indicating greater risk, at least in economic downturns.
The FICO Resilience Index score was developed by evaluating hundreds of thousands of anonymous credit profiles from before and after the Great Recession, evaluating which factors best predicted future delinquencies. However, like the algorithms for creating credit scores, the FICO Resilience Index scoring algorithm is kept secret.
FICO is partnering with Equifax and Experian in this pilot project, including the index along with credit scores when lenders conduct a hard credit inquiry, which is an inquiry for credit information and credit scores when the consumer applicant is applying for new lines of credit. However, FICO has not said whether the FICO Resilience Index will be available to the general public.
According to FICO, you must have at least 1 account opened for at least 6 months and that was reported to the credit bureau within that same timeframe. However it is difficult to see how such a sparse credit file could reliably predict resilience. Resilience is best predicted by net worth, since wealthier people have a much greater advantage in dealing with economic downturns, as has been repeatedly shown in previous economic downturns. But net worth is not listed in credit files, which credit scores of all types depend on, so FICO tested factors that are recorded in credit files that best predicts future delinquencies during economic downturns. It will take some time to test how well this index predicts future delinquencies.
Get Free Weekly Credit Reports from the 3 Main Credit Bureaus until April 2021, Now Extended to April 2022
The Covid-19 epidemic has shut down economies all over the world. In the United States, with a 15% of the population has become unemployed, so many of them cannot continue to make loan payments, which can have drastic repercussions both for the unemployed and for the rest of the economy. Hence, the federal government has enacted new laws to improve the situation for those affected by Covid-19.
Federal Covid-19 aid programs are granting temporary payment relief for those with federally backed mortgages, which applies to most mortgages, and some types of federal student loans. Payments on certain types of federal student loans are automatically suspended until September.
However, pausing payments may cause significant damage to consumers credit reports, which may lower their credit scores significantly. However, a spokesperson at FICO said that the special payment arrangements will not lower FICO scores, which have recently reached a record high of 703.
These special federal safeguards do not apply to other types of loans such as auto loans or credit card debt. Consumers will have to contact their lenders to see if they will be allowed to suspend payments or lower payments for a duration. The consumer must get permission from the lender before lowering or suspending payments; otherwise, the account will be marked delinquent in the credit report, decreasing credit scores. Although consumers could add a statement explaining missed payments because of the COVID-19 epidemic, credit scores will still be impacted negatively, since it is not easy to evaluate explanations with computer algorithms.
The federal program has instituted safeguards so that if payments are paused, then those accounts with paused payments must be marked as current in the credit reports. However, there are bound to be mistakes, so the federal program also allows consumers to start checking their credit reports for free every single week. Previously, they could only check each credit bureau report once annually for free. Now you can get free credit reports from each of the 3 major credit bureaus every 7 days until April 2021, which has been extended to April 2022 on March 15, 2021.
Even before the COVID-19 crisis, Equifax agreed with the Federal Trade Commission as part of a settlement for a data breach in 2017 to provide 6 free credit reports annually until 2026, so this will continue after the program offering free weekly credit reports is ended.
When going to annualcreditreport.com, you will be asked to provide proof of your identity by answering security questions, so it may help to have several years of credit information available. Note that you may have trouble accessing your credit reports if you have a credit freeze on your account.
Judging Creditworthiness without Credit Files
Most people in the world do not have a credit file, so how can their creditworthiness be assessed? For people without an extensive credit history, credit bureaus are starting to use court records, and rent, utility and phone bill payments. New startups that are trying other methods of assessing the creditworthiness of people living in 3rd world countries, most of whom do not have credit files, are analyzing online social networks of loan applicants — with their permission, of course — such as professional contacts on LinkedIn, looking at the number and nature of LinkedIn connections to coworkers, and even rating the contacts of potential borrowers.
Some startups are also using statistics to spot other patterns that may indicate creditworthiness or the lack thereof. For instance, it was recently found by one company that loan applicants who type only in lowercase or uppercase letters are less likely to repay loans. Some data providers are also looking at connections on Facebook. Loan applicants with friends who have well-paid jobs and who live in nice neighborhoods are deemed to be more likely to be creditworthy. On the other hand, having friends who recently defaulted on loans is a negative. - Credit scores: Stat oil | The Economist
More recently, the CRAs and FICO have established an alternate way of assessing creditworthiness:
- Experian Boost allows people without a credit history to use their payment history for utilities, such as gas, water, and electric, Internet/cable, and telecom payments, accomplished by giving Experian read-only permission to see your bank account data. You decide how many such payments you wish to add to the Experian credit file. You can discontinue the service at any time. Experian Boost will not have much of an effect for someone who already has a pretty good score. According to Experian, which uses the FICO Score 8 Model for this program. scores were boosted by an average of 13 points, which is negligible. However, it may provide more of a boost with people who have no credit history.
- Experian Boost is free. You connect your bank account used to pay your bills, then choose to verify the positive payment history you want added to your credit file. If there is a boost, it will be instant.
- With FICO’s program, the UltraFICO Score analyzes your bank account to see how well you manage your money and other factors that affect your score, such as how long accounts have been open, frequency of activity, maintenance of a savings balance and the total savings, and the avoidance of negative balances, as may occur with bounced checks.
- FICO, in conjunction with Equifax, developed a score, called the FICO Score XD, which uses information in cell phone and cable accounts provided by Equifax and on property records and other public data provided by LexisNexis Risk Solutions.
- Developed by TransUnion, the CreditVision Link relies on data from payday loans, checking account histories, frequency of home address changes, as well as the size of monthly payments and whether the payments were increasing or decreasing while the loan is outstanding. The credit score range for both the FICO Score XD and CreditVision Link were the same as for the FICO score, 300 to 850, with higher scores indicating a better credit risk.
Fannie Mae Starts to Use Trended Credit Data to Underwrite Consumers
In mid-2016, Fannie Mae started using trended credit data from all 3 credit reporting agencies — Equifax, Experian, and TransUnion — for all mortgage applications. The trended credit data focuses on credit data from the past 30 months, showing not only if payments were made on time, but whether the borrowers carried balances from month-to-month, paid off the balances in full, or at least paid more than the minimum. Studies by TransUnion have shown that consumers who carry balances or who only pay the minimum balance are a greater risk than those who pay in full. TransUnion estimates that trended credit data will put more consumers, from 12% to more than 21%, in the so-called Super Prime risk tier, who are offered the best credit terms.
Source: A Focus on Credit History for Mortgage Approvals - The New York Times
Resolving Disputes with the Credit Bureaus Will Become Easier
March 9, 2015 update: The credit bureaus use automated dispute resolution processes to correct errors reported by consumers, which is why mistakes in their credit reports frequently go uncorrected. In their settlement with the New York Attorney General's office, with changes being phased in over the next 3 years, the 3 credit bureaus will provide specially trained employees to resolve disputes. Additionally, the credit bureaus will establish a 6-month waiting period before listing medical debt, and any such debt that was reported, but subsequently paid by insurance, will be removed. - TransUnion, Equifax and Experian Agree to Overhaul Credit Reporting Practices - NYTimes.com
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
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.
Fair Isaac has altered its FICO scoring model, calling it FICO 08, to hopefully better predict consumer defaults. FICO 08 ranges from 300 to 850, and it will still rely heavily on total 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. 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
(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 intending to repay the loans, leaving the victims 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.
The laws of 39 states gave consumers some options to freeze their credit reports, 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. The freeze request can be made by mail, telephone, or email. Freezing is free for victims of identity theft.
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.
(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
The article below details the substantial increases of interest rates on credit cards, often, to more than 25%, 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.
- 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. 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.
- 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