Improve Credit Score Transparency or Risk Another Financial Crisis


Credit scores are vitally important in many areas of your financial life, ranging from getting loans and credit cards to saving on insurance rates, finding an apartment, or even getting your next job. Because of their importance, it's essential to improve credit score transparency to the point at which everyday borrowers will not only know where they stand on their credit but the reasons why their credit scores rise and fall over time.

What we do know
Credit-reporting agencies aren't entirely opaque about what goes into their credit score calculations. For instance, Fair Isaac , the company behind the popular FICO score, offers a detailed explanation of what goes into every person's score. A strong payment history without delinquencies or late payments carries the most weight, making up 35% of the FICO score, while 30% comes from how the amounts you owe compare to the total credit you have available to you. Smaller percentages of the score come from other areas, including the length of your credit history, the amount of new credit you've taken out recently, and how wide a mix of different types of credit you have outstanding.

Fair Isaac is also upfront about what it doesn't consider in its scoring. Legally protected information like race, religion, or marital status can't be used to determine credit scores, and Fair Isaac chooses not to consider age, employment history, where you live, or whether you're in a credit-counseling program, among other things.

Other bureaus have their own scores, such as the VantageScore product from Experian, TransUnion, and Equifax . VantageScore uses its own categories, with payment histories getting a 32% weight, credit availability and use 23%, total debt 15%, length of credit history 13%, recent credit history and inquiries 10%, and available credit 7%.

These formulas make the scoring process seem extremely complicated, giving only a glimpse at the overall process of coming up with a credit score. Exactly what goes into the point total is still a mystery, hidden as proprietary trade secrets of the companies involved.

Why you need to know
The reason that credit-reporting bureaus need to improve credit score transparency is that in some cases, every point counts. Consider:

  • In the mortgage loan arena, big lenders Bank of America , Citigroup , and Wells Fargo have had to rein in their credit standards substantially in the aftermath of the financial crisis, as bank regulators want to ensure that the events that brought the financial system to the brink of collapse never repeat. As a result, single points that push you above or below key credit-score thresholds are instrumental in determining whether you'll be able to buy the home you want and get financing at a fair rate.

  • In other areas, it's even less clear what your credit score means. For instance, in employment situations, just coming up with a baseline threshold is itself a matter of subjective judgment. Without the details on exactly where you stand on your score, you might never know that you didn't get a job because of your credit history.

Perhaps most important, keeping score calculations secret and relying on the credit-reporting bureaus to act as guardians of credit ratings puts a huge amount of responsibility on their shoulders. With many documented cases of erroneous credit-history information being used to calculate these scores, it's naive to take on faith that the resulting scores are correct -- yet there's currently no way to see exactly how an erroneous piece of information actually has a direct impact on your credit score.

Don't give up
A decade ago, having free access to a credit report seemed like a pipe dream, yet legislation now makes such disclosures mandatory on an annual basis. With the same drive and determination, consumers can demand that credit-reporting agencies improve credit score transparency to the point at which everyone will understand the ins and outs of the key financial metrics governing their financial lives.

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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.You can follow him on Twitter @DanCaplinger.

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