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.
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 MyFICO.com 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.