America runs on credit. The three-digit score represents how
likely a person is to pay his or her bills, and it impacts almost every
aspect of an American's financial life. It's like your passport into everything
that you need to do as an adult. And it affects so many things, not just
access to credit, so your ability to get a credit card, a mortgage, a reasonable
car loan. Landlords use credit reports and credit
scores, so it'll affect your ability to get an apartment. Insurance companies
use them. Having a low or no credit score can have
severe financial consequences. 42% of Americans said that their credit
scores prevented them from accessing financial products like credit cards or
loans. Life can become more expensive and more
difficult as your credit score falls. But some credit experts argue that the
current credit reporting and scoring systems have major issues. The current credit scoring system as it
stands is flawed. And this error of being fundamentally
misaligned has huge ramifications across the system for millions of Americans. Others say many of these criticisms are
misguided. The reality is that the credit reporting
system that we have here in the United States is sort of like the crown jewel
of the world. A lot of the criticisms are based on
some fundamental misunderstanding of how credit scores are calculated and how
they're used. If you take a moment to not be
knee-jerk angry about financial services for a minute, then I think a
reasonable person would have to conclude that these are actually good for
consumers relative to a world without credit scores and what that would mean
to our bottom lines. So how do credit scores work in America
and do they help or hurt consumers? A credit score usually refers to a
number between 300 and 850, which represents the holder's financial
stability and creditworthiness. The higher the number, the better a
consumer looks to potential lenders. Credit scores in the 500s are considered
to be very bad. Credit scores in the 600s, we're
starting to use terms like subprime, near-prime, getting close to average. But you really need to get yourself
into the 700s before you actually hit the national average, which is between
710 and 720. And then start working your way into the
elite level scores, which are well into the 700s and certainly into the 800s. Credit scores and reports are two
separate things. Reports refer to statements containing
information about your credit situation, while scores are calculated
based on that information from the report. The credit report is like the test you
took. The credit score is the grade you got
on the test. One is influential over the other, but
they're not the same thing. Today, scores calculated by Fair Isaac
Corp or FICO have become the industry standard, used by 90% of top lenders. They're calculated using five main
categories: 35% from payment history, 30% from the amount owed, 15% from the
length of credit history, and 10% for new credit and the types of credit you
have. It's based on an analytic algorithm. So we look at actual data patterns to
say what helps us predict whether you're going to pay credit in
the future. One of the main benefits of having a
credit score is that it provides a quick and empirically sound method of
measuring creditworthiness. Americans are borrowing today more than
ever, with household debt topping $16 trillion during the second quarter of
2022, making credit scores crucial to many businesses. It allows lenders to make very, very
precise decisions and have a very deep understanding of the likelihood of
someone paying you back. Experts say that such a streamlined
process is also the reason why Americans have been able to enjoy low-interest
rates for so many years. The credit scoring system allows the
industry to quickly and cheaply make decisions about whether or not
you're going to have credit. The cheaper it is for the lender to
decide whether or not they're going to give you credit, n the aggregate, the
lower the cost is for the lender and hopefully that gets passed along to the
consumers in a more efficient system. Without this system, lenders are going
to do what lenders do, which is they're going to mitigate their risk. What that means in practical terms is
higher interest rates because that's how lenders mitigate risk - they charge
everybody more to subsidize the risk that's posed by everyone. Or more declinations - it's easier to
say no to an applicant than to book an applicant who you know is going to
default on a loan. Representing a person's creditworthiness
using numbers also allegedly helped prevent lending discrimination. Lenders often relied on more subjective
methods of evaluation prior to the invention of credit scores. Credit scoring when it was first
developed was an advancement. It is better than having some banker
sit across from you and judge you and read the information in your credit
score because they bring a lot of their subjective analysis and their own life
experience into the analysis. And if their life is different than
your life, frankly, if it's some white guy sitting across from some woman of
color, that analysis can be flawed. If the information is not on a credit
report, it is systemically impossible for your credit score to be influenced
by it. What is not on your credit report? Things like your gender, your sexual
orientation, your politics, your level of education, how much money you make,
the socioeconomic makeup of your neighborhood, your level of
education. So we're able to assess credit risk
looking only at the past behavior that is on the credit report
and only to the extent that it predicts future credit risk. Yet, despite its good intentions,
experts say that the credit scoring system still suffers from
discrimination. A survey of 5,000 US adults found that
more than half of black Americans reported having a low or no credit
score, compared to 41% for Hispanics, 37% for whites, and 18% for Asian
Americans. Credit scores are based on past
performance. So you're going backward in history to
make a judgment about the future. The further we go backward in history,
the deeper the structural racism in the United States was. Intentional Racism that happened decades
ago gets baked into the cake, into the system, into the institutions and
policies of our society. And that kind of structural racism
requires no animus and no intent, but it still hurts black and brown consumers. If your parent put your name on a bill
because they had bad credit and then they were delinquent, you can turn 18
and inherit derogatory information on your credit report through nothing that
you did. If you're a new immigrant in this
country, your prior credit history doesn't travel with you. These credit bureaus are mostly
domestic, so you show up with nothing. And by the way, a blank slate is a bad
place to be in credit scoring. It means that you're un-scored and your
information starts off low and poor. 19% of American adults have no credit
history or are considered unscorable by existing systems. Sadly, what the scores do is they sort
of amplify those inequalities because they go in and they say, 'Okay, you're
already disadvantaged. Now you can be doubly disadvantaged'
because the score then sort of objectifies that you are somehow not
worthy of being given a chance, that you are somehow deserving
of much higher fines and fees than everyone else. Errors in credit reports can also often
lead to miscalculated scores. A survey in 2021 found that more than a
third of those polled found errors in their credit reports. Of more than 700,000 credit or consumer
reporting complaints received in 2021, more than half pertain to incorrect
information on their report. For me, it was a different person named
Aaron Klein who didn't pay their cell phone bill in New Jersey. I also happen to live in New Jersey for
graduate school, and this stuck with me for a year. One in 20 have an error so serious it
could cost them either the ability to get credit or a job or an apartment. However, those within the industry argue
otherwise. When we look at our data, it is
astronomically reliable. So we're constantly auditing and
evaluating our data. Our regulators are examining us on a
regular ongoing basis. So they're looking at all of our
systems around data integrity, data reliability, how we engage with
consumers, etc,. Under the Fair Credit Reporting Act,
credit bureaus are responsible for correcting any inaccurate information
on their reports. But research has suggested that many
consumers find errors difficult to get fixed. Credit bureaus are like a judge that
always rules for the defendant. So if your mortgage servicer says
you're late, even though you really were never late and you have documentation
that you were never late, it will still show up as late. Fixing mistakes is expensive and
time-consuming for the credit reporting and credit scoring industry. They are not incentivized to have
accuracy, particularly if the mistakes are symmetric and even out. Our entire role in the consumer credit
ecosystem is to provide reliable, accurate information. If we were unable to do that, nobody
would have any interest in engaging with us whatsoever. Our position is that the system only
works and we can only succeed if our data is incredibly reliable and
accurate. And that means engaging with consumers
continually to try to make sure that they're able to effectively managing
their credit and that they're able to effectively feel as though they can
interface with us about any concerns that they have. Another main concern is the lack of
regulation and oversight that can ensure fairness and transparency within the
industry. You know, I think the idea that the
industry is unregulated is a fiction. And we operate in one of the most
highly regulated spaces possible. You have a 50-year-old federal statute
called the Fair Credit Reporting Act, which essentially mandates
everything having to do with credit reports from our rights to challenge
information, our rights to freeze our credit reports, our rights to get
copies of our credit reports. You have the Consumer Financial
Protection Bureau, which regulates credit bureaus vis a vis credit report
accuracy. You have the Federal Trade Commission
that shares that regulatory responsibility. I must say that the Consumer Financial
Protection Bureau, which took over oversight of this industry about ten
years ago, they've done a really good job of trying to reform the credit
bureaus. But I would go further than more
regulation or even more laws. Over the years, credit reporting and
scoring agencies have made several changes in response to the criticisms
against the industry. Perhaps the biggest change comes from
the use of alternative data to improve accuracy and inclusion. They've started trying to incorporate
other, quote-unquote, nontraditional information. For example, if you pay
your mortgage on time every month, your credit score is going to increase. But if you pay your rent on time every
month, nothing happens because that information isn't reported. We've innovated with scores like the
FICO score XD and the ultra FICO score. They augment traditional credit data
with rich alternative data, such as how you pay your telco, utilities, as well
as information that's in your checking and savings account. The point of these new scores is to
allow consumers to find other ways besides the historical credit to
demonstrate their ability to repay credit. More regulatory changes could also be
coming. Two bills, the Protecting Your Credit
Score Act and the Comprehensive Credit Act, were both passed by the House in
2020, aimed at overhauling the credit scoring system with more oversight and
provisions aimed at protecting consumer credit. They have yet to be put on a
vote by the Senate. One of the initiatives that we're
championing because we really think the solution to a lot of these concerns
around how do you help consumers access financial products is an alternative
data piece of legislation called the Credit Access and Inclusion Act, which
would really encourage the reporting of rental data, utility data, bring new
data into the system that would allow literally millions of Americans to
access financial products and services. But ultimately, credit in its current
state is dependent on the consumer's financial decisions. I'll tell you the two things that you
need to do, and it will be impossible for you not to have a good score. Number one, never, ever miss a payment
on anything, ever. That's easy. It's writing a check at
the end of the month and paying your minimum payment, right? Number two, you've got to stay out of
credit card debt. And I'm not saying don't use credit
cards, I'm saying don't max out your credit cards. Don't use th as a
supplement to your income or to keep up with the Joneses or to impress
somebody. Pay your bills on time, stay out of
excessive credit card debt, lather, rinse, repeat, and you're going to have
fantastic credit scores. You know, 'how you manage your credit is
a sign of responsibility.' It's not. A lot of people have negative items on
their credit report because they were the victim of bad luck, not because
they're bad people. So they got sick, they lost their job
and now they can't pay their bills and their credit report is going to stop
them from getting a new one. That's crazy.
