The Sizable Trouble With Credit ranking Ratings

America runs on credit. The three-digit score represents howlikely a person is to pay his or her bills, and it impacts almost everyaspect of an American's financial life. It's like your passport into everythingthat you need to do as an adult. And it affects so many things, not justaccess to credit, so your ability to get a credit card, a mortgage, a reasonablecar loan. Landlords use credit reports and creditscores, so it'll affect your ability to get an apartment. Insurance companiesuse them. Having a low or no credit score can havesevere financial consequences.

42% of Americans said that their creditscores prevented them from accessing financial products like credit cards orloans. Life can become more expensive and moredifficult as your credit score falls. But some credit experts argue that thecurrent credit reporting and scoring systems have major issues. The current credit scoring system as itstands is flawed. And this error of being fundamentallymisaligned has huge ramifications across the system for millions of Americans. Others say many of these criticisms aremisguided.

The reality is that the credit reportingsystem that we have here in the United States is sort of like the crown jewelof the world. A lot of the criticisms are based onsome fundamental misunderstanding of how credit scores are calculated and howthey're used. If you take a moment to not be knee-jerk angry about financial services for a minute, then I think areasonable person would have to conclude that these are actually good forconsumers relative to a world without credit scores and what that would meanto our bottom lines. So how do credit scores work in Americaand do they help or hurt consumers?.

A credit score usually refers to anumber between 300 and 850, which represents the holder's financialstability and creditworthiness. The higher the number, the better aconsumer looks to potential lenders. Credit scores in the 500s are consideredto be very bad. Credit scores in the 600s, we'restarting to use terms like subprime, near-prime, getting close to average. But you really need to get yourselfinto the 700s before you actually hit the national average, which is between710 and 720. And then start working your way into theelite level scores, which are well into.

The 700s and certainly into the 800s. Credit scores and reports are twoseparate things. Reports refer to statements containinginformation about your credit situation, while scores are calculatedbased on that information from the report. The credit report is like the test youtook. The credit score is the grade you goton the test. One is influential over the other, butthey're not the same thing. Today, scores calculated by Fair IsaacCorp or FICO have become the industry.

Standard, used by 90% of top lenders. They're calculated using five maincategories: 35% from payment history, 30% from the amount owed, 15% from thelength of credit history, and 10% for new credit and the types of credit youhave. It's based on an analytic algorithm. So we look at actual data patterns tosay what helps us predict whether you're going to pay credit inthe future. One of the main benefits of having acredit score is that it provides a quick and empirically sound method ofmeasuring creditworthiness.

Americans are borrowing today more thanever, with household debt topping $16 trillion during the second quarter of2022, making credit scores crucial to many businesses. It allows lenders to make very, veryprecise decisions and have a very deep understanding of the likelihood ofsomeone paying you back. Experts say that such a streamlinedprocess is also the reason why Americans have been able to enjoy low-interest rates for so many years. The credit scoring system allows the industry to quickly and cheaply make decisions about whether or notyou're going to have credit.

The cheaper it is for the lender todecide whether or not they're going to give you credit, n the aggregate, thelower the cost is for the lender and hopefully that gets passed along to theconsumers in a more efficient system. Without this system, lenders are goingto do what lenders do, which is they're going to mitigate their risk. What that means in practical terms ishigher interest rates because that's how lenders mitigate risk – they chargeeverybody more to subsidize the risk that's posed by everyone. Or more declinations – it's easier tosay no to an applicant than to book an.

Applicant who you know is going todefault on a loan. Representing a person's creditworthinessusing numbers also allegedly helped prevent lending discrimination. Lenders often relied on more subjectivemethods of evaluation prior to the invention of credit scores. Credit scoring when it was firstdeveloped was an advancement. It is better than having some bankersit across from you and judge you and read the information in your creditscore because they bring a lot of their subjective analysis and their own lifeexperience into the analysis.

And if their life is different thanyour life, frankly, if it's some white guy sitting across from some woman ofcolor, that analysis can be flawed. If the information is not on a creditreport, it is systemically impossible for your credit score to be influencedby it. What is not on your credit report? Things like your gender, your sexualorientation, your politics, your level of education, how much money you make,the socioeconomic makeup of your neighborhood, your level ofeducation. So we're able to assess credit risklooking only at the past.

Behavior that is on the credit reportand only to the extent that it predicts future credit risk. Yet, despite its good intentions,experts say that the credit scoring system still suffers fromdiscrimination. A survey of 5,000 US adults found thatmore than half of black Americans reported having a low or no creditscore, compared to 41% for Hispanics, 37% for whites, and 18% for AsianAmericans. Credit scores are based on pastperformance. So you're going backward in history tomake a judgment about the future.

The further we go backward in history,the deeper the structural racism in the United States was. Intentional Racism that happened decadesago gets baked into the cake, into the system, into the institutions andpolicies of our society. And that kind of structural racismrequires no animus and no intent, but it still hurts black and brown consumers. If your parent put your name on a billbecause they had bad credit and then they were delinquent, you can turn 18and inherit derogatory information on your credit report through nothing thatyou did.

If you're a new immigrant in thiscountry, your prior credit h istory doesn't travel with you. These credit bureaus are mostlydomestic, so you show up with nothing. And by the way, a blank slate is a badplace to be in credit scoring. It means that you're un-scored and yourinformation starts off low and poor. 19% of American adults have no credithistory or are considered unscorable by existing systems. Sadly, what the scores do is they sortof amplify those inequalities because they go in and they say, 'Okay, you'realready disadvantaged.

Now you can be doubly disadvantaged'because the score then sort of objectifies that you are somehow notworthy of being given a chance, that you are somehow deservingof much higher fines and fees than everyone else. Errors in credit reports can also oftenlead to miscalculated scores. A survey in 2021 found that more than athird of those polled found errors in their credit reports. Of more than 700,000 credit or consumerreporting complaints received in 2021, more than half pertain to incorrectinformation on their report.

For me, it was a different person namedAaron Klein who didn't pay their cell phone bill in New Jersey. I also happen to live in New Jersey forgraduate school, and this stuck with me for a year. One in 20 have an error so serious itcould cost them either the ability to get credit or a job or an apartment. However, those within the industry argueotherwise. When we look at our data, it isastronomically reliable. So we're constantly auditing andevaluating our data.

Our regulators are examining us on aregular ongoing basis. So they're looking at all of oursystems around data integrity, data reliability, how we engage withconsumers, etc,. Under the Fair Credit Reporting Act,credit bureaus are responsible for correcting any inaccurate informationon their reports. But research has suggested that manyconsumers find errors difficult to get fixed. Credit bureaus are like a judge thatalways rules for the defendant. So if your mortgage servicer saysyou're late, even though you really were.

Never late and you have documentationthat you were never late, it will still show up as late. Fixing mistakes is expensive and time-consuming for the credit reporting and credit scoring industry. They are not incentivized to haveaccuracy, particularly if the mistakes are symmetric and even out. Our entire role in the consumer creditecosystem is to provide reliable, accurate information. If we were unable to do that, nobodywould have any interest in engaging with.

Us whatsoever. Our position is that the system onlyworks and we can only succeed if our data is incredibly reliable andaccurate. And that means engaging with consumerscontinually to try to make sure that they're able to effectively managingtheir credit and that they're able to effectively feel as though they caninterface with us about any concerns that they have. Another main concern is the lack ofregulation and oversight that can ensure fairness and transparency within theindustry.

You know, I think the idea that theindustry is unregulated is a fiction. And we operate in one of the mosthighly regulated spaces possible. You have a 50-year-old federal statutecalled the Fair Credit Reporting Act, which essentially mandateseverything having to do with credit reports from our rights to challengeinformation, our rights to freeze our credit reports, our rights to getcopies of our credit reports. You have the Consumer FinancialProtection Bureau, which regulates credit bureaus vis a vis credit reportaccuracy. You have the Federal Trade Commissionthat shares that regulatory.

Responsibility. I must say that the Consumer FinancialProtection Bureau, which took over oversight of this industry about tenyears ago, they've done a really good job of trying to reform the creditbureaus. But I would go further than moreregulation or even more laws. Over the years, credit reporting andscoring agencies have made several changes in response to the criticismsagainst the industry. Perhaps the biggest change comes fromthe use of alternative data to improve accuracy and inclusion.

They've started trying to incorporateother, quote-unquote, nontraditional information. For example, if you payyour mortgage on time every month, your credit score is going to increase. But if you pay your rent on time everymonth, nothing happens because that information isn't reported. We've innovated with scores like theFICO score XD and the ultra FICO score. They augment traditional credit datawith rich alternative data, such as how you pay your telco, utilities, as wellas information that's in your checking and savings account.

The point of these new scores is toallow consumers to find other ways besides the historical credit todemonstrate their ability to repay credit. More regulatory changes could also becoming. Two bills, the Protecting Your CreditScore Act and the Comprehensive Credit Act, were both passed by the House in2020, aimed at overhauling the credit scoring system with more oversight andprovisions aimed at protecting consumer credit. They have yet to be put on avote by the Senate. One of the initiatives that we'rechampioning because we really think the.

Solution to a lot of these concernsaround how do you help consumers access financial products is an alternativedata piece of legislation called the Credit Access and Inclusion Act, whichwould really encourage the reporting of rental data, utility data, bring newdata into the system that would allow literally millions of Americans toaccess financial products and services. But ultimately, credit in its currentstate is dependent on the consumer's financial decisions. I'll tell you the two things that youneed to do, and it will be impossible for you not to have a good score.

Number one, never, ever miss a paymenton anything, ever. That's easy. It's writing a check atthe end of the month and paying your minimum payment, right? Number two, you've got to stay out ofcredit card debt. And I'm not saying don't use creditcards, I'm saying don't max out your credit cards. Don't use th as asupplement to your income or to keep up with the Joneses or to impresssomebody. Pay your bills on time, stay out ofexcessive credit card debt, lather, rinse, repeat, and you're going to havefantastic credit scores.

You know, 'how you manage your credit isa sign of responsibility.' It's not. A lot of people have negative items ontheir credit report because they were the victim of bad luck, not becausethey're bad people. So they got sick, they lost their joband now they can't pay their bills and their credit report is going to stopthem from getting a new one. That's crazy.

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