by John Ulzheimer, Credit Expert for CreditSesame.com
In late 2012 the Consumer Financial Protection Bureau ("CFPB") published a study analyzing the differences between credit scores sold to lenders versus those sold to consumers. The study suggested that the different scores provided "similar information about the relative creditworthiness of consumers," but that for a small percentage of consumers, different scoring models gave "meaningfully different results."
The CFPB is also now encouraging lenders to provide free credit scores to their customers. Inevitably this brings up a sensitive issue among consumers and their advocates and a question the 2012 CFPB study left unanswered: are consumers better off with so many credit scores?
Consumer frustration about this issue is understandable, but a large selection of credit score options is healthy because it benefits consumers through competition in the market. As such, the downside of score confusion is certainly outweighed by the benefits.
If you looked exclusively at credit bureau based risk-scoring systems, you'd find over five dozen options that lenders can choose from. Those models are referred to as "generic" scoring systems, which means they're sitting on a shelf and any lender in the United States can buy and use them for risk assessment for any variety of credit obligation. The next time you walk down the soft drink aisle at your local supermarket, count the number of options available and you'd have a pretty good idea of how many credit scoring model options are commercially available for lenders.
And while there are dozens of scoring systems available for use by lenders, those models were developed by only a small handful of companies, including VantageScore Solutions, FICO, and the credit bureaus themselves. Each of the credit scoring models available to lenders essentially compete against each other as they're all designed to do pretty much the same things. What's also a given is that every one of those models will perform differently in their efforts to predict the likelihood that a consumer will become delinquent on their credit obligations.
When a lender chooses a scoring model to use, they'll normally test several options against each other to determine which does the best job of identifying future "bads" from those consumers who make their payments on time. This is generally done using a process called "validation." If one model identifies more future bad payers than another, that model has "won" the head to head match up and is generally implemented by the lender for their use in underwriting. This is the considerable value of having many different scoring models to choose from.
If only one model was available, then lenders wouldn't have the ability to test multiple options for the best performing tool. That would leave all lenders at a disadvantage because their loss rates would be much higher than necessary. But, that disadvantage wouldn't reside firmly on the shoulders of lenders. Consumers would likely be the ones who would be asked to subsidize the lender's risk.
Whenever a lender identifies that there is financial risk of doing business with certain groups of consumers they have a choice to make. They can either avoid doing business with them or, they can ask consumers to subsidize their risk by paying higher interest rates and fees. There's no doubt we would all be paying higher interest rates if there were limited, or only one, credit scoring model option.
So whether it's free from a lender, through any number of websites or through the purchase of a credit monitoring service, any time we can expose consumers to credit scores and the context around how that score was calculated, consumers benefit. They benefit because credit score management is not taught at any level of academia and until the early 2000's, only consumers who also happened to work in the financial services environment knew anything about credit scores.
Today we live in an environment where most people are familiar with the concept of credit scoring. Interest rates are relatively low and credit can be extended within a very short period of time. Innovations in credit scoring and the competitive pressure to produce the most accurate and innovative credit risk management system are in a large part responsible.
Regardless of how many scores are sold to consumers or given away free, or how many models are available for use by lenders, all of them are based on the same three credit reports. That makes credit score management as easy as ensuring that the information on your three credit reports is accurate and speaks glowingly of your credit management practices.
John Ulzheimer is a nationally recognized expert on credit reporting, credit scoring and identity theft. He is twice Fair Credit Reporting Act certified by the credit industry's trade association and has been an expert witness in over 140 credit related cases to date. Since 2004, John has been interviewed and published over 3,000 times on the topics of personal finance and consumer credit. Formerly of Equifax and FICO, John is the only recognized credit expert who actually comes from the credit industry.
California is the worst state for foreclosures, and unemployment and bankruptcy also are severe problems, according to CardRatings.com. State unemployment rate in July 2012: 10.7 percent (Labor Department).
Arizona has the second worst foreclosure rate in the country, and many Arizonans also have low credit scores, according to CardRatings.com. State unemployment rate in July 2012: 8.3 percent (Labor Department).
Many Floridians are stuck in foreclosure, delinquent on their credit card debt, unemployed, bankrupt, or have low credit scores, according to CardRatings.com. State unemployment rate in July 2012: 8.8 percent (Labor Department).
Georgia is one of the worst five states in unemployment, bankruptcy rates, average credit score, and credit card delinquency rates, according to CardRatings.com. State unemployment rate in July 2012: 9.3 percent (Labor Department).
Nevada has the worst unemployment rate, personal bankruptcy rate, and average credit score in the country, according to CardRatings.com. State unemployment rate in July 2012: 12.0 percent (Labor Department).
Iowa has a lower than average unemployment rate, lower than average credit card delinquency rate, and higher than average credit score. State unemployment rate in July 2012: 5.3 percent (Labor Department).
Montana has above-average credit scores, fewer personal bankruptcies, fewer foreclosures, and less delinquent credit card debt than other states, according to CardRatings.com. State unemployment rate in July 2012: 6.4 percent (Labor Department).
South Dakota has better than average employment and credit scores, according to CardRatings.com. It also has fewer personal bankruptcies, fewer credit card delinquencies, and fewer foreclosures. State unemployment rate in June 2012: 4.4 percent (Labor Department).
Vermont was second best in the country in the foreclosure and personal bankruptcy categories and was above average in the other three categories. State unemployment rate in July 2012: 5.0 percent (Labor Department).
North Dakota "may be the best-kept secret in the country," CardRatings.com says. It was the best state in three categories, including unemployment, and fourth best in the other two, according to CardRatings.com. But remember that if you move there, you would have to live in North Dakota. State unemployment rate in July 2012: 3.0 percent (Labor Department).
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