Stop Blaming FICO Scores

I read a blog post calling for the “death of FICO”. I don’t know when this anti credit score movement began, but perhaps it was Dave Ramsey with his I love debt scores description for credit scores. On the SavingAdvice.com website, a site I really like, Jennifer writes how the credit card industry is making FICO obsolete through its actions. Let me address her comments:

“The credit card industry and banks, in their effort to cut their liabilities and reduce the amount of open credit on their books are slashing credit limits and closing accounts and lines of credit left and right.”

Well, the problem with “left and right” is it implies that this is happening to a majority of accounts. In reality, American Express is lowering limits on 10% of their portfolio. Other card companies are doing a less than majority lowering of limits as well.

“When FICO calculates your credit score, a huge part of that score is your available credit to debt ratio.”

Actually, the credit utilization ratio impacts part of your Amounts Owed part of the FICO score. This wedge of the FICO credit score pie is 30% of your score and the ratio is one part of this, not all of it. So, her argument is flawed that the issuers are having a huge impact on this.

“Now, imagine that you’re the person with $30,000 in available credit and $1,000 of debt. You’re doing great. Now one credit card company closes your card, chopping $10,000 off your available credit. Another drops your limit by $5,000. Now you’re down to $15,000 in available credit. Then, for giggles, your bank drops your HELOC by $5,000. You’re now sitting at $10,000 in available credit and $1,000 in debt. You’re still in an okay place debt-wise, but your FICO score has, by now, dropped quite a few points through no fault of your own.”

Jennifer is right that your score is impacted through no fault of your own in some, perhaps many cases, but her “quite a few points” assertion is vague. Most consumers won’t feel this impact, but I agree with her, this practice is unfair. But, I disagree that will lead to the downfall of FICO as the model is still predicting risk for the masses.

“Lenders and others with whom you want to do business will have to go old school. They’ll have to actually get to know the people they’re making loans to and bringing into the workplace. They’ll have to look at the total picture of the person, ranging from employment history, to prior experiences with debt”

Jennifer’s recommendation is for lenders to “go old school”. Let’s take a long hard look back and what that really looked like. It meant being judged by your race, gender, religion or some other non-risk assessing factor. The issue with this credit crisis is that Liar’s loans were made – where nothing but a credit score was used to assess risk. Income and assets do matter, and should be assessed in that risk. Did FICO benefit financially from a switch to these loans? Not directly. Sure, loan apps were up and FICO did benefit, but not in a way where they promoted this behavior. I was at the company and we were telling lenders to be careful. The line was “credit scores are ONE factor, not THE factor in assessing risk”. So, what happens if we remove the calculation and the person from the exercise. We did this in a class where we were handed a number of credit reports and asked to score them -using just our brains, no technology – based on our review of the documents. The result. More defaults and more declines for credit. Humans just make more mistakes.

Lots of folks like to bash the SAT exam for being biased. It might be flawed, but look at what the educational decisioning system looked like before the exam. It was all blue-bloods in college. The SAT may not have created a perfect meritocracy, but it created more of a meritocracy than existed before.

To the user who commented:

“the number was good until it was released to the public then it became trash,I have never worried about my fico I just pay my bills and have always had a great fico,but if they manipulate the fico I will not change my plan top accomadate it,always makes me grit my teeth when people talk about getting this kind of debt or that trying to raise the fico the fico bit is a good racket for those selling it,very smart of them ,like other finacial products make people believe they cannot live without it and convince them they love it ,masses and masses of sheepless”

What you are asking for is a lack of transparancy. Sure, large companies have been created and made millions selling related products to consumers, but has consumer harm really increased? What we don’t know is how many consumers have saved money through their education or at the least awareness. The consumer exposure has lead to a free government mandated site for consumers – AnnualCreditReport.com. As for gaming the score, I can tell you that credit card companies were extremely concerned about this mean these consumer services launched. But, studies proved that as scores improved, risk improved as well.

Finally, Jennifer doesn’t point out that despite the credit limit declines and the apr raises, credit scores are actually on the rise. This could mean that more credit will be made available, but perhaps not. It used to be that a 720 was a great score and now lenders want a 760+.

What I love about these articles most is that they call for scraping the credit score system without suggesting a solution. It’s the same story I hear about the SAT scoring system for college admissions. Sure, the test is flawed, but where are the alternatives?

The credit scoring models are not perfect and they were never intended to be used solely in decisioning. Instead, of calling for their destruction, we should be looking for ways to improve the system. Transparency led to some users taking advantage of the authorized user loophole and that led to FICO ’08 featuring a method to close that loophole. This is how evolution should occur.

How To Stop Subscription Auto-Renews

Today, I was cleaning out my emails and I saw an email notice that I was getting canceled from an annual service I signed up for to do web site directory listing because my credit card was not working.

What had happened has probably already happened to you. My card was compromised earlier in the year and I got a new card with a new card number. To no surprise, I didn’t update services that I don’t really use, so when they try to auto-renew me, it didn’t work.

Light bulb goes off. My idea is for an annual credit card cleanse. The idea is that by having all these services on your old card numbers, you will be forced to go through them to figure out if you really want to renew them. But, wait. This is a drag to do for every card in your wallet – when the average American has four credit cards.

Light bulb goes off again. When you sign up for auto-renews, classify your auto-renew in one of two ways. First, for utilities and must haves use your primary card(s). Next, use your secondary cards for nice to haves. For me, these are Consumer Reports, Zagat, and Pandora just to name a few of my non-essential annual subscriptions. On these, use your secondary credit card(s). Now, for your secondary card, you can do this credit-cleanse once a year. That way, these services will make you really take note on whether you are really using them. If you don’t use them, you simply take no action – ignore the emails you get begging you to change your credit card info.

Since April 15th is tax day, let’s make May 15th, credit cleanse day.  On this day, call in your credit card as lost or stolen and have them issue a new card with a new card number.  Once you get it, use the card for all your non-essential subscription purchases.  Then, put this date in your electronic calendar for next year and report that card lost again.  Rinse and repeat.  Make sense?

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