Your Credit Score May Never Be the Same
Sometimes we don't know exactly how broken things are until after they get fixed.
Case in point: Fair Isaac Corp., the company that created the model used to calculate the scores underlying millions of consumer loan and credit decisions.
The New York Times described Fair Isaac's formula as "one of the most widely used and influential credit scores." The information it generates is used in the credit reports generated by Equifax, Experian and TransUnion, the three big companies that gather information on individuals and track their credit ratings. It is hard to overstate the influence of FICO, as the company and its namesake scoring system are called.
Like all models, FICO has its flaws. Last week, the bad news was we learned how much more deeply flawed this model was than we previously understood. The good news is that Fair Isaac has been cajoled by the Consumer Financial Protection Bureau, an agency created by the Dodd-Frank Act, into applying more balance and fairness in its metrics.
There were two significant changes: The first involves medical bills that go into collection. These are now given less weight. As the Wall Street Journal reported, "More than half of all debt-collection activity on consumers' credit reports comes from medical bills," according to data from the Federal Reserve.
The rationale for changing this is reasonable: Many of these bills are disputes between insurers and health-care providers. The fight over payment often leads to medical-service providers putting unpaid portions of these bills into delinquency status. The first time the consumer finds out that there was an issue between their insurer and doctor is a dunning notice from a debt-collection service and notice of nonpayment on their credit report.
This is a situation brought about by our complex and overpriced health-care system, tightwad insurers and medical-service providers that irresponsibly run up charges. That these circumstances ever existed reflects poorly on the brain trust at Fair Isaac. How does a fight between insurers and care providers reflect on a consumer's creditworthiness?
The second change is subtler, though perhaps an even bigger issue: The old model made no distinction between unpaid collection efforts and bills that have already been paid. The newer FICO model ignores paid accounts that are in collection.
I am running out of G-rated metaphors for the people at Fair Isaac who built a model like this. Of all of the information that goes into constructing a credit score, one would imagine that paying back a debt would be high on the list of favorable events. That Fair Isaac didn't differentiate between paid and unpaid bills is beyond embarrassing.
The U.S. economy, though on the mend, still is operating below capacity. Lots of blame for that falls on our banking system. After being wholly irresponsible, giving credit to anyone who could fog a mirror, they now have swung to the opposite extreme.
Meanwhile, a flaw in the credit reporting system has been identified and fixed. Maybe credit for those who deserve it will be easier to obtain.
One cheer for Fair Isaac, for acknowledging the flaws in it credit-scoring models, and three cheers for the CFPB, for taking this on in the first place.
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To contact the author on this story:
Barry L Ritholtz at email@example.com