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Tuesday, September 22, 2009

Informative article about the problems with credit scores

I often tell people that ask (and even some that don't ask) that nobody can explain how a credit score is calculated, not even the people that work for the credit bureaus.  So many things affect your score - your payment history, how much you pay, your debt to income ratio, your debt to credit limit ratio, etc.  So many factors affect your score that it is virtually impossible to determine what exactly causes your score to be what it is.

Dale Quinn with the Arizona Daily Star delved into the calculation of credit scores.  Here's what he found:
Credit scores. Three-digit numbers that can cost consumers thousands of dollars every year.


The score influences interest rates for mortgages and car loans. It affects insurance premiums. Employers and landlords can even use the numbers to decide whether a person will land a job or secure housing.

And, consumer advocates say, the reports are often loaded with errors and arbitrary penalties that cost people money.

Kenneth Benner, a consumer advocate and retired broadcaster living in Marana, said the problem can be aggravated for those who are victims of identity theft, who can spend years trying to repair their credit scores. In the meantime, they pay the penalty with higher interest and insurance rates.

Benner has received grant money and is working on a research project examining how credit scores are determined. He is also a board member of the Arizona Consumer Council.

The difficulty of getting mistakes on credit reports fixed and the seemingly arbitrary method of reducing scores puts consumers at a disadvantage, he said.

Also, the scores from the three main credit bureaus — Equifax, TransUnion and Experian — can vary with little explanation to the consumer as to why. And that can make a difference depending on which score a lender looks at, Benner said.

For their part, the credit bureaus urge consumers to keep track of what's on their credit reports.

"We encourage consumers to review their credit reports regularly and to contact us if they see anything that doesn't look right," said Steven Katz, a spokesman for TransUnion. "Consumers are entitled to one free credit-report disclosure every 12 months from each of the three national credit-reporting companies and we encourage them to obtain these."

The problem with that, said Ed Mierzwinski, a consumer program director with the U.S. Public Interest Research Group, is that the credit report a consumer sees is not as detailed as one viewed by a lender.

Those reports can include information from individuals with similar names, and that can drive down a consumer's credit score, he said.

There's also a lack of transparency in how the scores are calculated, Mierzwinski said. While the system reduces human bias, it also lacks discretion a person would exhibit when examining the report.

"Credit scoring is based on credit reports, and credit reports are often full of mistakes," Mierzwinski said.

A January report by the National Consumer Law Center said as many one in four credit reports have serious errors.

And Mierzwinski said that number could be even higher.

He said the use of credit scores by employers and landlords should be banned. If someone defaults on a credit card, it doesn't necessarily mean he's going to crash his car, Mierzwinski said.

Melissa Stoloff, a spokeswoman in Arizona for the Allstate insurance company, said the company does use the scores to determine its customers' premiums and that research has shown individuals with high credit scores are a lower risk to insure.

"In rating and underwriting insurance we use several factors with credit being one of them," she said. "It's something that allows us to reward customers that are less likely to incur a loss with lower premiums."

Conversely, consumers with low credit scores will pay higher premiums, she said. Allstate has a contract with TransUnion and gets its credit scores from that bureau, she said.

Benner also pointed out that a consumer who is shopping for a good loan would be punished with a lower credit score because applying for credit reduces the number.

Essentially, Benner said, bureaus can see that as an increasing risk factor. The assertion was backed up by the Web site MyFico.com. But it did say searching for a good rate won't have too much impact on a credit score.

"Looking for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from auto, mortgage or student-loan lenders within a short period of time," the Web site says.

Still, Benner said, even small drops in credit scores can mean hundreds of dollars in extra payments.
The full article can be found here - http://www.azstarnet.com/business/309735.

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