Credit scores and what they mean : Bad Credit Advisor

Credit scores and what they mean

I politely disagree with Anya Kamenetz of Generation Debt, at least with some content of her article - What You Need to Know About Credit Scores. I am going to digest it for you step by step. This is a very specific topic and should be covered from several different angles. I of course, has done some due diligence on credit scores, reports and history.

... credit reports yield credit scores, a powerful little three-digit number ranging from 300 to 850. A bad credit score - less than 620 is considered subprime, will have you paying 10.99 percent interest on a car loan when your friend with squeaky-clean credit is paying 6 percent, or 29 percent on a credit card when your friend's card charges 12 percent.

There are few things in this statement which are not quite accurate. The credit score range often depends on where you get credit reports from. The popular free credit reports have recently shown the following score ranges -
Experian is 330 - 830, TransUnion is 300 - 850, Equifax is 300 - 850. But the actual credit reports pulled by the lenders have
Experian at 300 - 850, TransUnion at 336 - 843, Equifax at 300 - 850. While the difference is small it exists. More importantly, the credit score of under 620 is not longer bad. It is very bad. In today's credit meltdown you don't want to be below 660. And Anya, the word subprime is ... if not profane, then is rather obsolete. And the rates depend on few other factors like salary, length of employment and how established or old your credit history is.

Credit scores can also affect your rates for mortgages and home, auto, and life insurance. And increasingly, bosses are conducting credit checks when they make hiring decisions. Credit scores are a great scam for the credit card industry. Without fail, when I give a talk on college campuses about the dangers of credit cards, someone in the audience asks, "But don't we need a credit card to build a good credit score?" And I have to say, well, yes. You need those credit cards to get a mortgage or an auto loan down the road. But you don't have to run up any balances! The most cautious thing to do is to use your credit cards to make a regular payment, like a cell phone bill, and then set up automatic bill paying online each month.

The credit scores for mortgages and home, auto, and life insurance, as well as for hiring decisions are calculated using very different algorithms and often differ from each other quite drastically. I will illustrate this later. As far as calling them a great scam, it is ... well a bit too far. Just like driving responsibly, using credit card responsibly is something that's given. You don't drink and drive, so once you get your student credit card, don't get yourself all euphoric and plunge into shopping spree. Besides, the credit limits on the student cards are rather small. Setting up automatic bill payment from checking account seems like a smart idea, as long as you don't go under the minimum balance on this account, or worse yet, have no sufficient funds. Then you may get in troubles with both, your bank and credit card account. Your credit scores won't look nice afterwards. The bottom line is be very careful if you decide to set up automatic bill paying.

If you have a problem with old fashion mail payments, e.g. your roommate is messy or your dog chews your mail, set up online payments. What you also must do is to set up email alerts on your credit card account to remind you within 5 to 10 days from due date, that payment is due. Please don't tell me that some credit cards won't do it. I currently have it with Chase, Discover, American Express, Target REDCard and Commerce BankCard. And you can set all kinds of alerts to monitor unusual ATM activity, excessive bills, etc.

Moving on ... three different credit bureaus combine information from credit card companies and banks to make credit reports: TransUnion, Experian, and Equifax. Each of these bureaus may have slightly different information on you in their reports, which yields a different score. The Equifax score is seen by some as being most similar to what banks actually see when they pull your credit report.

This is not exactly right. The information often varies a lot among the three bureaus, and credit scores differ significantly. That is why 3-in-1 credit report monitoring is so important. Worse, occasionally some negative information is reported with one or two bureaus, but not with the third, e. g. you can have collection record on TransUnion and/or Equifax reports but not on Experian. So ordering Experian report in this case will do you little good. On a contrary, it will mislead you to think that everything is fine.

The notion that Equifax score is seen as being most similar to actual reports pulled by lenders isn't precisely correct. When you apply for a mortgage, TransUnion credit report will be initially pulled as a rule of thumb, so bank would get a vague idea on where you stand, followed by merged report from all three bureaus with middle score being a decisive one. For car loans, Equifax is generally used by various credit unions, while car dealers use TransUnion or Experian, and only one is often enough.

In the The Score Decoded part, the picture gets a bit too generalized. When it comes to factoring the 5 variables - ... Payment history - the biggie, about 35 percent of a FICO score ... Amount owed - about 30 percent ... Length of history - about 15 percent ... New credit - about 10 percent ... Miscellaneous - about 10 percent, almost no one ever mentions that the percentages or weights given by the scoring algorithms to these variables actually vary, depending on the type of a loan you are looking for.

Equifax, TransUnion and Experian use at least 3 different scoring algorithms for 3 different types of credit - mortgages, auto loans, and consumer credit, because these different types of loans carry different default risks. These algorithms differ in what they mean to predict, the statistical methods used to determine a credit-worthiness score, and what data points are used and how they are weighted. Equifax uses Beacon 5.0 for home mortgages, but Pinnacle for auto loans. TransUnion uses FICO Classic 04 and Empirica Auto 95, while Experian uses Isaac/Fair Model II and Advanced Risk Model respectively. So between 2 algorithms used by the same credit bureau, credit score can differ anywhere from 30 to 80 points, resulting in quite different rates for a home mortgage and a car loan. Since cars depreciate very quickly and homes don't, the current and/or potential debt weighs negatively for the auto loans. If you have 2 credit cards with large credit limits and no balances, it is great for a mortgage, but when shopping for a car, you may want to close them.

So someone who has a $2,000 balance and a $2,000 credit limit - they're maxed out - will look worse than someone who owes $3,000 but has cards with $30,000 worth of limits. This may hurt folks with large student loan balances.

The problem with this statement, is that student loan is an Installment type of a loan. The balance to credit limit ratio is applicable only to Revolving type loans, like credit card or home equity lines. So folks with large student loan balances are perfectly fine, at least in this regard.

Finally, it is OK to shop for a credit, and it doesn't make you look desperate, as long as you keep hard inquiries or pulls under 2 a week, and you have an established credit history. Having something like 3 credit accounts each going back at least 30 months, allows you to shop around for the best credit deal with relative immunity.

Fri Aug 29, 2008 02:08PM by Tony | More in Credit Bureaus | Comments (0)

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