If you're a little savvy about credit, you probably know that each of us is entitled to a free copy of our credit report, once a year, from each of the three main credit-reporting agencies. (You can access these easily online at annualcreditreport.com.) And if you're willing to pay a few dollars, you can get your credit score, as well.
That's great, but according to our new national financial watchdog, the Consumer Financial Protection Bureau, credit scores vary widely, and the ones you're given may be very different from the ones lenders and other businesses actually use.
Because your credit score is used for much more than just predicting how reliable a borrower you'll be (potential employers and landlords check it, as do some utility companies, insurers, and even car-rental companies), a poor score can doom you to steep interest rates and even outright rejections. It can cost you tens of thousands of dollars, or more.
Big Numbers, Big Costs
The CFPB looked at 200,000 credit records from each of the three main credit-reporting agencies: Experian, TransUnion, and Equifax (EFX). Each agency uses its own algorithms to calculate credit scores, and each one actually has more than one way to do so.
Meanwhile, the Fair Isaac company also computes credit scores, and it alone has more than 49 models. (Its scores are the most well known, dubbed "FICO" scores.)
All that complexity might be OK if it didn't result in wide variations. But wide variations are exactly what the CFPB found.
The good news is that most results -- 73% to 90% -- were relatively consistent: If you receive a high score from a model used to generate a score given to consumers, you'll most likely also get a high score with a model used to generate scores for lenders. But not always.
Between 19% to 24% of the time, consumers would get a score different enough to bump them into the next score category -- potentially a worse one. And the remaining 1% to 3% of consumers would receive credit scores that differed by two or more score categories.
The $50,000 Difference
How much of a difference does it really make if you end up in one category versus another? Here's some information, from the horse's mouth: The FICO website offers a handy calculator that lists the different typical interest rates offered to different FICO score categories.
Below are national average interest rates for someone seeking to borrow $150,000 for a 30-year, fixed-rate mortgage:
FICO score of 760-850: 2.889%
FICO score of 700-759: 3.111%
FICO score of 680-699: 3.288%
FICO score of 660-679: 3.502%
FICO score of 640-659: 3.932%
FICO score of 620-639: 4.478%
When it comes to interest rates on long-term loans, seemingly small differences can add up to big money. For example, the best category above results in a monthly payment of $623, while the worst category demands $758. That's a difference of $1,620 per year.
But look at the lifetime interest paid on the two loans, and the dollars really add up: The best category leaves you paying a total of $74,446 in interest, while the worst category will eat up $122,905 in interest -- a difference of $49,459. Even the difference between the best category and the next-best one will cost more than $6,000 in total interest paid.
Some small differences in credit scores can cut you off from a mortgage entirely. According to the CFPB report: "Fannie Mae generally won't buy mortgages with FICO scores under 620. So, for consumers whose scores are in the relevant range, a small variation in a consumer's score might result in his or her score falling above or below such a cut-off, with dramatic implications for his or her access to home loans."
What to Do
The CFPB study shows that you shouldn't put too much stock in any credit score you might purchase. It might be significantly different from the one a lender or other business is given. That said, consumers are not totally powerless in this situation.
What you can -- and should -- do is request your free credit reports each year from annualcreditreport.com, and review each closely. It's far from uncommon for them to contain errors, which you can ask to have corrected. Remember that those very influential credit scores are based on information in your credit report. Here's one weighting, from FICO:
35%: Your bill-paying history
30%: How much of your available credit you've borrowed against
15%: The length of your credit history
10%: The variety of credit you carry
10%: The number of "hard inquiries" from creditors (such as when you try to take out a loan or open a new credit card account)
An ideal credit report will show a long history of on-time payments on a variety of debt (such as a mortgage, car loan, and/or credit cards). It will also reflect that you haven't been maxing out your available credit and that there haven't been lots of inquiries on your account lately. Much of this is under your control, and over time you can build a strong credit history that results in high credit scores.
Even if the credit score you're given isn't so hot, remember that the lenders or businesses you're dealing with might have been given a significantly different one for you, and possibly a higher one. It can pay to shop around, and not resign yourself to unattractive terms.
The variation in scores isn't great news overall, but it could work in your favor.