Consumer access to credit, housing, insurance, basic utility services, and even employment is increasingly determined by centralized records of credit history and automated interpretations of those records.
Credit histories in one form or another have long been an important factor in decisions to extend or deny credit to consumers. Historically, such decisions required a skilled, human evaluation of the information in an applicant’s credit history to determine the likelihood that the applicant would repay a future loan in a timely manner. More recently, computer models have been developed to perform such evaluations. These models produce numerical credit scores that function as a shorthand version of an applicant’s credit history to facilitate quick credit assessments.
During the second half of the 1990s, mortgage underwriting increasingly incorporated credit scores and other automated evaluations of credit histories. As of 1999, approximately 60 to 70 percent of all mortgages were underwritten using an automated evaluation of credit, and the share was rising.
The automated quantification of the information in credit reports has not simply been used to decide whether or not to extend credit, but has also been used to set prices and terms for mortgages and other consumer credit. In certain cases, even very small differences in scores can result in substantially higher interest rates, and less favorable loan terms on new loans. Credit scores are also used to determine the cost of private mortgage insurance, which protects the lender, not the consumer, from loss but is required on mortgages with down payments of less than twenty percent. Lenders also review credit histories and/or credit scores to evaluate existing credit accounts, and use the information when deciding to change credit limits, interest rates, or other terms on those accounts.
In addition to lenders, potential landlords and employers may review credit histories and/or credit scores. Landlords may do so to determine if potential tenants are likely to pay their rent in a timely manner. Employers may review this information during a hiring process, especially for positions where employees are responsible for handling large sums of money. Utility providers, home telephone, and cell phone service providers also may request a credit report or credit score to decide whether or not to offer service to consumers.
Insurance companies have also begun using credit scores and similar insurance scores that are derived from the same credit histories – when underwriting consumer applications for new insurance and renewals of existing policies. Credit information has been used as a basis to raise premiums, deny coverage for new customers, and deny renewals of existing customers – even in the absence of other risk factors, such as moving violations or accidents. Some providers claim that credit scores are also used to offer insurance coverage to consumers who have previously been denied, or to lower insurance rates. This is a highly contested issue that is under review in dozens of state legislatures and insurance commissions.
Thus, a consumer’s credit record and corresponding credit score can determine access and pricing for the most fundamental financial and consumer services.
Contents
I.About Privacy
II. The Growing Importance of Credit Scores
III.Controversial Issues Affecting Consumers
A. Speed
B. Customized or Risk-Based Pricing
C. Effect on Discrimination
D. Statistical Validity
E. Untested Scoring Formulas
F. Inaccurate credit reports
IV. How Does the System Work?
A. Non-Mortgage Credit
B. Employment and Services Other Than Loans
C. Other Data Providers
D. Mortgage Credit
1. Portfolio Loans
2. Loans Sold in the Secondary Market
3. Credit Rescoring
4. Federal Housing Administration (FHA) and Department of Veterans’Affairs
(VA) Loans
V. Study Design
A. Phase One
B. Phase Two
C. Phase Three
VI.Findings
A. Phase One
1. Almost One in Ten Files was Missing a Credit Score from at Least One
Repository
2. A Substantial Number of Files Met the Criteria for Further Review
3. Numerous Files Contained Additional Repository Reports and Information not
Relevant to the Consumer’s Credit History
4. Scores Reported by the Three Repositories for a Given Consumer Varied
Substantially
5. Reports Contained Limited Information to Help Consumers Understand the
Principal Reasons for their Credit Scores
6. In Depth Reviews Revealed Significant Errors and Inconsistencies, Some of
Which were Likely Artificially Lowering Consumer Credit Scores, and Some of
Which were Likely Artificially Raising Consumer Credit Scores
B. Phase Two
1. Scores Reported by the Three Repositories for a Given Consumer Varied
Substantially
2. Reports Scored With Different Versions of Scoring Software Reflected Almost
No Difference in Overall Variability of Credit Scores
3. Reports Contained Limited Information to Help Consumers Understand the
Principal Reasons for their Credit Scores
C. Phase Three – Specific Types of Errors
1. Significance and Frequency of Errors of Omission
2. Errors of Commission
3. Merging and Compilation Errors
VII.Conclusions and Implications of the Findings for Consumers
A. Credit scores and the information in credit reports vary significantly among repositories
B. Many consumers are unharmed by these variations, and some probably benefit
from them
C. However, tens of millions of consumers are at risk of being penalized for
incorrect information in their credit report, in the form of increased costs or decreased access to credit and vital services
D. Almost one in ten consumers runs the risk of being excluded from the credit
marketplace altogether because of incomplete records, duplicate reports, and mixed files.39
E. The use of information from all three repositories in mortgage lending protects consumers and creditors from being negatively affected by errors of omission, but it may increase the negative impact on consumers of errors of commission.
F. Consumers are not given useful and timely information about their credit
1. Standardized, generic explanations do not provide sufficient information for consumers to address inconsistencies and contradictions, let alone outright errors.
2. Consumers outside of California have no affirmative right to know their credit scores
G. Private companies without significant oversight are setting, or at the very least heavily influencing, the rules of the marketplace for essential consumer services that base decisions on credit scores.
H. Certain information in credit reports has the potential to cause breaches of consumers’medical privacy.
VIII. How to Improve the System
A. Require creditors to immediately provide to any consumer who experiences an
adverse action as a result of their credit reports or credit scores a copy of the credit reports and scores used to arrive at that decision free of charge and permit disputes to be immediately resubmitted for reconsideration
B. Require decisions based on a single repository’s credit report or credit score that result in anything less than the most favorable pricing to immediately trigger a reevaluation based on all three repositories at no additional cost
C. Strengthen requirements for complete and accurate reporting of account
information to credit repositories, and maintenance of consumer data by the
repositories, with adequate oversight and penalties for non-compliance
D. Establish meaningful oversight of the development of credit scoring systems
E. Address important questions and conduct further research
IX.Recommendations for Consumers
Download
PDF Ebook Credit Score Accuracy and Implications for Consumers
