Government Report: Is the FICO Credit Score Worth Buying?

Is the FICO credit score you buy the same one lenders use when considering you for a loan? If not, what’s the difference? And what’s the point of buying a score that lenders don’t even see?

The newly formed Consumer Financial Protection Bureau (CFPB) has been trying to answer these questions for the last few weeks. On July 19, they sent a report to Congress with some of their findings. It might be old news to folks in the lending industry. But it’s a real eye-opener for consumers. Here’s a summary of the CFPB’s findings.

The (Real) Purpose of Credit Scores

Your credit score is a numerical snapshot of your creditworthiness. Basically, it shows how you have borrowed and repaid money in the past. Are you the kind of person who pays bills on time? Or do you have a habit of blowing off your creditors? Your credit score will answer this question — more or less.

From a lender or creditor’s perspective, the purpose of the credit score is simple: It indicates how likely you are to default on a loan. This is what it all comes down to. When you apply for an auto loan or mortgage, the lender wants to know how risky you are as a borrower. So they buy a credit score (one of several varieties) that gives them insight into your financial past.

The score makes life easier for lenders and creditors. They can buy your credit score to gain insight into how you’ve borrowed money in the past. It also indicates how likely you are to pay back the loan. Statistics make this possible. Statistically, a person with a lower credit score is more likely to default (fail to repay a loan).

Your score comes from information within your credit reports. Scores and reports are two different things, but they are directly related to one another. Your reports contain information about your various credit accounts, dating back several years. Car loans, student loans, retail accounts, credit cards — all of these things show up in your reports.

But it’s how you handle these debt obligations that really matters. Your payment history influences your credit score more than any other factor. Pay your bills on time, and you’ll have a higher score. Blow off your creditors, and you’ll have a low score.

In the United States, there are three companies that gather this kind of data. They are commonly referred to as consumer credit-reporting agencies, or CRAs for short. You may have also heard the term “credit bureaus” used to describe them. The three companies are TransUnion, Equifax and Experian. The information they collect is used to produce a credit score, as shown below.

The Credit Reporting Process

You borrow money from lenders and creditors. This activity gets reported to the three credit-reporting agencies. The data gets fed into a computerized scoring model to produce a three-digit credit score. Easy enough, right? Stick with me. This is where things get complicated.

FICO, VantageScore and Other Scoring Models

There are many different credit-scoring models in use today. These are software programs that convert all of that credit-report data into a score. According to the CFPB report, the FICO score is the one used by most lenders when reviewing loan applicants. Some lenders use other scoring models. In fact, “many of the credit scores sold to lenders are not available for purchase by consumers.”

And just when you thought it couldn’t get any more confusing…

The credit-reporting agencies (CRAs) we discussed earlier produce their own credit scores. And they are all unique to the particular company that created it:

  • The “Equifax Credit Score” has a range of 280 – 850.
  • The “Experian Plus Score” has a range of 330 – 830.
  • The “TransRisk New Account Score” (from TransUnion) runs from 300 – 850.
  • There’s also a “VantageScore” used by all three of the CRAs.

The standard FICO score mentioned earlier has a range of 300 – 850.

Consumers can also buy their own credit scores to see where they stand, in terms of qualifying for a loan. But the score purchased by the consumer might be different from the one the lender sees. Now we are getting to the heart of that matter — and the reason for the government’s involvement.

Why is the Government Investigating the Credit Industry?

The credit-reporting industry is heavily regulated by the federal government. In fact, the Fair Credit Reporting Act (FCRA) goes so far as limiting how long an item can stay on your credit report. So why is the government delving into the credit industry anew? The answer to this question can be found in the Dodd-Frank Wall Street Reform and Consumer Protection Act, or “Dodd-Frank Act” for short.

The Dodd-Frank Act was signed into law this time last year. It just turned one year old yesterday, on July 21. It has been hailed (and sometimes criticized) as the most sweeping financial regulatory act of the last 50 years. Among other things, it established the Consumer Financial Protection Bureau mentioned earlier. It also gave the CFPB one of its first marching orders — to study the differences between credit scores purchased by consumers, and the ones used by lenders and creditors. The CFPB’s initial findings were released on July 19, 2011 (view news release on CFPB website).

The CFPB focused its attention on the following questions:

  • How are the credit-scoring models developed?
  • How can a single consumer have different numerical scores?
  • How do creditors use the different scoring models when considering loan applicants?
  • Which credit scores are consumers are able to buy
  • Key question: Does the difference between scores sold to creditors and those sold to consumers put the consumer at a disadvantage in some way?

“One way consumers have tried to empower themselves is by knowing their credit scores,” said Elizabeth Elizabeth of the CFPB. “We are assessing whether purchasing a credit score provides a consumer with the information he or she needs.”

In other words, is it worth the money to buy your credit score?

There are many different scoring models in use today. So it’s entirely possible for consumers to see a different score than the one used by the lender with which they are applying. You might buy your credit score from the website, or from one or more of the CRAs. But where does the lender get their score? You wouldn’t know unless you asked them. And if the lender sees something different from the consumer, does it hurt the consumer’s ability to shop for a rate and negotiate?

According to the CFPB, these differences in scoring could actually put the consumer at a disadvantage. Why? Because the consumer might not have a true picture of their creditworthiness.

Our Advice: When to Buy Your Credit Score

Yes, there are many different scoring models out there. But the FICO score is widely accepted as a legitimate source of “predictive analysis.” It shows the lender how you’ve borrowed and repaid your debts in the past. Even if the lender uses a different scoring system, it’s beneficial for consumers to see their own FICO scores. It gives you a good idea where you stand, in terms of creditworthiness. It also helps you negotiate for rates and terms.

For instance, let’s say I buy my FICO credit scores from two of the three CRAs. They come out to an average of 805. This is considered an excellent score by any lender, regardless of what model they happen to be using. So I know I’m a “well qualified borrower” with a FICO number in this range.* Thus, I’m in a position to hold out for the best rate available. If I’m not happy with the rate being offered by one lender, I can just keep shopping. I don’t have to settle. I’m not desperate, because I’ve got that excellent credit score working for me. Eventually, I’ll find a lender willing to offer their best rate.

I would not have this kind of insight if I didn’t check my score. So in a sense, it doesn’t matter if the lender is using a different scoring model. As long as I’m seeing a legitimate score that’s widely accepted in the industry (i.e., FICO), it’s still useful information. So it’s worth the $20 or so I have to pay to receive it.

With that being said, there’s really no reason to buy your credit score unless you’re going to apply for a car loan or a mortgage. Those are the only two circumstances where consumers benefit from knowing their scores. If you’re the kind of person who pays cash for most things, then who cares what your score is? You could go your entire life without needing or knowing it.

* Your credit score is not the only thing lenders use when considering you for a loan. Mortgage lenders in particular will look at a wide variety of factors, including your debt-to-income ratio. Still, your score plays a major role in whether or not you get approved for the loan. It will also determine the interest rate you receive on the loan.

Credit Reports and Rent Payments: It’s About Time

Experian (one of the three credit-reporting bureaus in the U.S.) is starting to add rent payments to some of their credit reports. They began doing this in January, but it’s just now coming out in news circles. This is a positive sign for consumers, and one that is long overdue.

This means that renters who pay their rent on time could eventually see improvements to their credit scores. And renters who don’t have any other credit lines can establish a credit history for the first time. Previously, rental data was not reported to the credit bureaus.

In order for the payment history to show up on a person’s credit report, it has to be reported by a landlord. It will take time for landlords and property managers to realize this change. And even then, some of them won’t be inclined to report the on-time payments. Still, it’s a step in the right direction. Currently, Experian receives rent-payment information from about 8 million landlords. That number is expected to rise in the future.

Experian is one of the three major credit bureaus in the United States (see below). They are global corporation with headquarters in Dublin, Ireland. You might also know them from their and commercials. You know, the ones with all the singing.

Credit Reporting Bureaus 101

There are three credit-reporting bureaus in the United States — Experian, TransUnion and Equifax. Though they are commonly referred to as “bureaus” or “agencies,” they are actually private-sector corporations. They’re also heavily regulated by the federal government, through the Fair Credit Reporting Act (FCRA).

Why should you care about credit-reporting bureaus? Because the data they report has the power to make or break your chances of getting a loan. When a lender reviews your application for a mortgage or auto loan, they will check your credit score. These scores come directly from the information reported by the credit bureaus.

Here’s how the credit-reporting industry works, in a nutshell:

The Credit Reporting Process
Want to use this graphic? Feel free. Please link back to the source.

If you’re like most Americans, you probably got your first credit card when you were in your 20s. Maybe you got your first car loan around that time, too. Either one of these things would mark the beginning of your credit history. That’s because they both get reported to the credit-reporting bureaus: Experian, TransUnion and Equifax. Student loans, store credit cards and mortgage loans can also be reported to the bureaus.

The bureaus keep a record of all credit accounts in use. More importantly, they keep a record of the consumer’s payment history for each of those accounts. On-time payments, late payments, debt collections — all of these things are recorded within your credit report.

The information in your reports is then put through a scoring model (such as the popular FICO model) to produce a score. The FICO score goes from 300 on the low end to 850 on the high end. Higher is better.

So, your financial activity gets reported to the three credit-reporting bureaus, where it is compiled into a data file. This is your credit report. The data then gets put through a scoring system to produce your credit score. You have three scores in all — one for each of the credit bureaus (see diagram above).

Rent Payments on Credit Reports is Long Overdue

Rent payments should have been added to credit reports a long time ago. It’s long overdue, and I’m disappointed to see only one of the three credit bureaus taking steps in that direction. In the absence of such information, lenders will not be able to fully evaluate someone who could be a good candidate for a loan.

Fewer Americans are using credit cards today than in the past. And many people who do have credit lines have stopped using them. We have become a credit-wary nation, in the wake of our economic recession. Credit cards and mortgage loans are the two most common ways to establish a credit history (and the score that results from that history). So, in the past, consumers who didn’t have a credit card or mortgage had trouble establishing a credit history. When they did apply for a mortgage loan, they would often be rejected for having an insufficient credit history — a “thin file” in industry jargon.

The lender’s perspective was this: “We cannot determine how well you’ve repaid your debts in the past, so we cannot measure the risk of giving you a loan. Sorry. Try again next year.”

By incorporating rental data, the credit-reporting bureaus will allow responsible consumers to prove they are responsible. This is good for all parties involved.

At this time, only Experian is making this change. The other two credit-reporting bureaus, Equifax and TransUnion, do not include rent information in their credit reports. Nor have they signaled any intent to follow suit. Perhaps some prodding is in order.

TransUnion and Equifax Need to Catch Up

Now that Experian is paving the way for rent payments on credit reports, it’s time for TransUnion and Equifax to get on board. It’s in everyone’s best interest, including the credit bureaus themselves. It gives consumers another way to demonstrate their financial responsibility. It gives lenders more insight into the consumer’s risk level. And it gives the credit-reporting bureaus more data to report on more people (i.e., more stuff they can sell). This last item is important because these are, after all, corporations with profit-hungry shareholders.

So get on board, TransUnion and Equifax. Don’t let the train leave you at the station.

Average U.S. Credit Score Won’t Get the Best Rates

Credit Report SampleYour credit score could make or break your chances of getting a mortgage loan. So it’s important to know where you stand, before you apply for a loan.

There’s nothing wrong with being average, per se. But when it comes to your FICO credit score, being average means you probably won’t get the best mortgage rates. That’s because the average credit score in the U.S. is too low to qualify for the best interest rates.

Depending on who you ask, the average credit score in the U.S. is somewhere between 670 and 690. I actually found several different averages when researching this story. I got one number from FICO, the company that designed the FICO credit-scoring model.

I got a different number from Experian, which is one of the three credit-reporting companies in the U.S. And I found even more averages reported in various news sources. So let’s say the “average of averages” is around 680 on the FICO scale.

Average FICO Score Falls Below “Excellent”

Some perspective would be helpful at this point: FICO credit scores above 640 are generally considered good, while those above 760 are considered excellent. A credit score below 640 is considered fair to poor. If your FICO score is in the 500 range, you’re part of the “bad credit” club. Again, these are general numbers. If you ask 20 mortgage lenders to define excellent, good and bad credit scores, you’ll probably get 20 slightly different sets of numbers. But they’ll probably be close to the numbers above.

So, by this definition, the average credit score in the U.S. fall into the good-but-not-excellent range.

According to the most recent U.S. Housing and Mortgage Trends report by CoreLogic, credit-score requirements have risen sharply over the last few years. Their data shows the following:

  • In 2010, 60% of conventional mortgage loans originated in 2010 had a FICO credit score of 780 or higher.
  • In 2005 (during the housing boom), only 25% of originated loans had FICO scores of 780 or higher.

You could interpret this data in two ways: (1) consumers as a whole have improved their credit scores, or (2) lenders are rejecting people they’ve approved in the past. The second scenario is the accurate one. Lenders have raised the bar, and a higher percentage of borrowers are simply being turned away.

Related article: Credit score needed to buy a house

When you consider the average credit score in the U.S. (and the type of score that’s needed to get the best rates), one thing becomes clear. Most Americans will not qualify for the best mortgage rates being offered. They might qualify for a mortgage loan, and that’s certainly good news. They just won’t get the lowest rates the lender has to offer. They will pay a premium for being average.

Credit Score is One of Several Criteria

This is not to say that anyone with a credit score above 760 is going to get the best mortgage rate. Lenders look at a variety of factors when reviewing a loan application. They will consider the size of the down payment, the borrower’s debt-to-income ratio, and other factors. In order to qualify for the best rates on a mortgage loan, you’ll need to have all three bases loaded. You’ll need a down payment of 20%, a credit score in the mid-700 range or higher, and a reasonable debt-to-income ratio.

How to be Above Average

So what can you do if your FICO credit score is average, or below average? There’s really no mystery to it. In fact, if you do a Google search for “how to improve my credit score,” you’ll see the same advice repeated over and over. Pay all of your bills on time. Reduce your credit card balances. Clean up any errors on your credit reports. And don’t open any new credit accounts unless you absolutely need them.

People who make it seem more complicated than this are probably trying to sell you something. Don’t buy it. You can do these things yourself. In fact, you’re the only person who can do them.

What is a Good Credit Score in 2011?

What is considered a good credit score these days? This is one of the most common questions we receive from our readers. And as we replace our 2010 calendars with new ones for 2011, this question will surely see a spike in frequency again.

So, in anticipation of all those emails, I thought I’d share my own definition of a good credit score in 2011:

Looking Back: A Credit Score History

Are credit scores really that important for home buyers? Yes. In fact, they are more important today than at any point in the last decade. If you bought a home in 2003, for example, your credit score would not have weighed as heavily toward the lender’s final decision. If you had good income and a decent down payment, you would’ve been approved for a loan — even if your credit score was lackluster.

Things have changed. In 2011, your credit score has the power to make or break the mortgage approval, all by itself. Lenders (and investors in the secondary mortgage market) are putting more emphasis on credit scores as a risk-management tool. So you can bet it’s one of the first things they’ll review when you submit your mortgage application. We’ve reverted back to an era of sensible lending, for the time being anyway.

So What’s a Good Score in 2011?

2011 Credit ScoresLet’s talk goals before we talk numbers. As a home buyer, you have two mortgage-related goals. You want to get approved for the loan, obviously. But you also want to get a decent interest rate, meaning a rate that’s close to the current national average.

So by that definition, a good credit score in 2011 is one that helps you qualify for a mortgage loan with a relatively low rate — your two primary goals as a borrower.

So let’s talk numbers. What does it take to qualify for a loan in 2011, from a credit standpoint. Consider the following. Traditionally, FHA loans have been the best option for people with weak credit. These are government-insured loans, so the credit-score requirements are generally lower than those for a conventional / non-government-insured loan.

In 2011, the minimum allowable credit score for an FHA loan is 500. If you want to qualify for the 3.5% down payment program, you’ll need a score above 580 (related story).

But here’s the rub. Both of these numbers (500 and 580) are basically moot, because the lenders who make these loans will require even higher credit scores.  Bloomberg news recently reported that Bank of America and Wells Fargo, the two biggest mortgage lenders in the U.S., have raised their minimum credit-score requirements from 620 to 640 for some FHA loans. Other FHA-approved lenders will likely require a score of at least 620 for approval.

So, for the most part, the FHA’s minimum requirements don’t really matter. You still have to go through a lender, and they have higher minimum requirements.

What about conventional mortgage loans, those that aren’t backed by the government? Historically, it has been easier to obtain an FHA loan than a conventional mortgage. So if most lenders are requiring a credit score of 620 or higher for FHA, you can bet they’re doing the same thing for conventional — at a minimum.

Other Qualifying Factors

Credit scores are important. But they’re not everything. Your income and debt levels are equally important. If you don’t have enough income for the size of loan you want, you won’t get approved. Also, if your current debt obligations are eating up too much of your monthly income, you’ll hit a snag. But those are subject matter for another story.

Here’s what it all boils down to:

If you want to qualify for a home loan in 2011, you’ll need to have stable income, manageable debts, and a good credit score. But the definition of “good credit” has been reset to pre-housing-boom levels. A good credit score in 2011 can best be defined as a FICO score of 620 or higher. This doesn’t mean you couldn’t get approved for a loan with a score below that level. It’s possible. This is just the nearest we can come to a hard definition for a soft target.