Getting a Personal
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You Are Not Your Credit Score
by Brent Hunsberger

Consumers with high FICO scores (we're talking 760 to 789) are now more likely to default on their home loan than on their unsecured credit card debt, Fair Isaac Corp. said.

This reversal of a long-held tenet came about not only because of the bad economy, company CEO Mark Greene said, but also because of "counterintuitive trends in consumer behavior."

Let's see. Would that be like walking away from a home worth less than what you paid for it?

Fair Isaac's announcement is almost laughable. Perhaps unintentionally, it points to a major problem facing FICO, its competitors and lenders --credit scores aren't as accurate as they used to be.

It also shows why you shouldn't be as concerned about your credit score as the industry wants you to be.

Credit scores are based on history, after all. And history has changed.

The main question is this: If people with great credit scores are defaulting more often than expected on their real estate loans, how can lenders rely on the scores?

I posed this question Thursday to Barry Paperno, consumer operations manager for Fair Isaac.

His response: Good question. We'll get back to you.

(The company responded in writing on Friday: "The newest FICO . . . formula does the best job yet of any score on the market.")

Another question with no clear answer: How will scores going forward reflect the extraordinary times of the past two years?

Will they factor in the irresponsible lending, exotic financial instruments and iresponsive banks that forced people into short sales, foreclosures and other credit-damaging circumstances? After all, many borrowers with good credit scores took out subprime loans as the housing boom gathered steam, for reasons ranging from greed to naivete to fraud.

Paperno's response: We will. We've adjusted before. Trust us. "We are always redeveloping the scores based on the most current data available," he said.

Unfortunately, that's about all we can do. Trust Fair Isaac. Because the methods the company and its competitors use to develop credit scores are closely guarded.

Yet these numbers, in the recent debt bubble, wielded tremendous power.

Think about it.

Credit scores and their close cousins affect your homeowner and auto insurance rates. They can determine the interest rate offered on your mortgage. They can dictate the kind of credit card you get.

Even utilities are considering reporting billing histories to the nation's major credit-reporting bureaus.

"The credit score agencies' job is to sell credit scores," said Calvin Bradford, a sociologist based in Virginia and longtime consultant for lenders on community reinvestment issues. "They've been very, very good at selling credit scores to consumers. And to every industry you can think of."

Economists say there might not have been anything wrong with FICO's scoring system before the downturn, per se. Lenders simply leaned too heavily on it.

At the height of the housing run-up, lenders --especially subprime lenders --approved mortgages based solely on a person's credit score. They did this as fast as they could, because volume was key to their success, and nobody wanted to be left holding these "no-doc loans" when they went bad, Bradford said.

A 2005 study of mostly community banks found nearly half used credit scores and, most specifically, the score of the small-business owner, to underwrite small-business loans. This surprised the authors, because community banks trumpet how they lend based on relationships and other "soft" information.

In short, we became addicted to credit scores as we became hooked on debt.

Now, as we discard our debt, we need to end our credit-score fix, too.

Fortunately, we've already started.

The Oregon Legislature voted last week to limit many employers from using credit histories in hiring decisions. Washington already has restricted the practice.

Late last year, Oregon fined Farmers Insurance Co. of Oregon $10,000 for violating state law when it used credit histories to re-rate customers' auto and homeowner policies. (Insurers still can use credit scores to deny you initial coverage.)

"The problem is, certain entities are using credit scores for purposes they're really not appropriate for," said Chi Chi Wu, a staff attorney with the National Consumer Law Center, a consumer advocacy group.

Paperno, of Fair Isaac, answering a different question, echoed this assertion: "The score isn't a tool to reward you or penalize your past behavior. It's more to take what you've done and predict (behavior) based on that."

Even lenders are questioning the scores. So says John Enyart, president of Portfolio Financial Servicing Co., a Portland-based loan servicer. His firm manages the billing and payments --even some credit evaluations --of $9 billion in commercial and consumer loans. Enyart said lenders for months have questioned why credit scores didn't predict the default rates they now see in their portfolios.

"The credit scoring model is broken," he said. "It has not held up the way we anticipated it would have."

So, here's what I suggest: Check your credit report every year if you want. But don't pay to know your score if you're not applying for a loan. It doesn't matter that much. Most consumers have a good idea of what it is anyway.

Nearly two in three consumers accurately estimated their credit scores in 2000, according to a study by George Washington University marketing professor Vanessa Perry. Only 5 percent underestimate them.

The nearly one-third of folks who overestimated scores, the study found, generally are less knowledgeable about what affects their scores and less likely to budget, save or invest regularly, Perry found.

Those results tell me that most people don't need to obsess about how to improve your score. Borrow responsibly, and a good lender will lend you money whether your score is 650 or 750.

Pay your bills on time. Don't keep high balances. Borrow only when necessary.

Think twice before opening a new card or line of credit. And if your card reduces your credit limit, there's a simple fix. Cut your balance outstanding, and your score should correct itself, Paperno said. Because your score is based on the gap between your total balances and your total credit line, not the credit line itself.

Right now, Fair Isaac's latest scoring model, FICO 8, is being rolled out to lenders. Unfortunately, it's based mostly on loans made before the crisis. And Paperno could not say when a newer model would replace it.

So the assumptions behind these scores, until further notice, were not based on today's reality. As Greene of Fair Isaac suggests, we consumers no longer behave intuitively.

At least, not to the intuitions of FICO's mathematicians.

"Credit scores were built in good times," Wu said. "It remains to be seen whether the mathematicians in FICO can adjust the models for bad times."

Copyright 2010 The Oregonian All Rights Reserved

Source: The Oregonian (Portland Oregon) February 28, 2010, www.oregonlive.com/, BYLINE: BRENT HUNSBERGER, 503-221-8359; brenthunsberger@news.oregonian.com   www.oregonlive.com/itsonlymoney

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