The following opinions having to do with FICO 2008 have been submitted and included as op/ed features and do not necessarily reflect the opinions of Credit Management Inc (CMI) or it’s management or staff.  They are, however, deemed relevant and thought provoking and responses from our subscriber base or readers are encouraged.

Arguments For and Against FICO scoring

Pro

Say what you will about the villains of credit, those institutional faceless bodies who determine perhaps the most sacred tenet of our economic infrastructure—access to capital.  By this I am referring to the collusion of FICO, the credit bureaus and lenders.  Yes they are secretive, yes they are profitable, yes they consider you a number, yes they are imperfect…and yes they are necessary.

40 years ago, if you wanted a loan, you walked hat in hand into the office of a banker. The banker determined from the look of you, and your supporting evidence, and what you wanted the money for, whether to loan you money and at what term.  God help you if you were not white and didn’t attend the same church as the banker.  The old adage at the time was,“banks only loan money to those who don’t need it.”

Then came credit cards—the old fashioned kind—where you had to pay off the entire balance every month. Then came the idea of unsecured lines of credit.  These were the aggressive, wild, wild, west type creditors who relied on your word that you’d manage your debt.  Before long, they figured out their bad debt and default ratios compared to their interest and fee based income and managed a tidy profit from debtors. Their only means to collect on overdue outstanding debt were harassing collection efforts and derogatory remarks on your credit report.  This being their only leverage, they needed the entire industry to subscribe to the same reporting metric and form a kind of credit cartel.  So along comes the FICO score.

Now, with FICO, borrowers are also faceless which could be a good thing.  And, loans can be processed efficiently.  Have you ever gotten instant financing or a mortgage approval in 24 hours?  You can thank FICO for that.  And FICO scores don’t care if you’re over weight, been divorced 3 times, have zero dollars in your savings account, or wear fur.  With FICO, you are judged solely on your credit history, and how that history ranks you statistically among your peers. 

Some people say that credit scoring came to fore with equal opportunity to give everyone a fair chance at gaining credit.  I personally don’t think lenders are that thoughtful.  I think they wanted a way to decide on loans faster.  Efficiency equals faster loans and faster loans equal faster commissions, fees, points, and interests to banks.  So they, along with the credit reporting bureaus, created a formula from various inputs and gauged the accuracy over time and determined that their formula, and credit score, effectively indicated the risks associated with loaning money to various profiles.  Today, this formula works well enough that over 80% of the nation’s largest lenders use FICO scores as a primary credit worthiness indicator— and they price their loans accordingly.

But still there are those who complain that their credit reports are wrong, or that the cable company screwed up on their billing, or that their bankruptcy 5 years ago was, well, 5 years ago.  Granted, credit reports are imperfect and it’s a real pain to set the record straight.  But break it all down to brass tacks and you still want a loan and you’re at the mercy of the lender.  So therefore, you can’t complain.  Shouldn’t the lender get to decide who they offer money to and at what terms?  And at least by using a score, compiled from numerous inputs from numerous sources, the credit decision is based on statistics as opposed to a personal judgment.  Money is an object and its better that the loaning of money remains objective.

Consider FICO scores the current means of gaining access to capital.  Don’t fight it unless you know of a better, fairer way and intend to sway the entire banking industry to your way of thinking. Learn to live within its confines.  Complaining won’t get you credit but nudging your credit profile into the good graces of FICO can.  Although the secret formula of FICO is restricted information, there’s plenty of information available to head you in the right direction toward improving your score and gaining capital.  Next time you chastise FICO and the credit scoring system, consider the alternative.  I don’t even believe your
rich uncle would be any more lenient or objective than FICO when it comes to loaning you money.

Con

FICO is inherently flawed and sways the advantage of acquiring credit unfairly.  The FICO score is an attempt to make all things equal when applying for credit but nothing is ever equal with regard to money or how it’s used.

How is it that a millionaire entrepreneur with 90 employees can have a lower fico score than the same company’s 22-year-old receptionist?  Easy, the entrepreneur is managing 50 times the debt load, 10 more credit cards, 3 more credit lines, car payments on 6 company cars, a $300,000 equipment lease, yet the millionaire’s been in the same business for 20 years.  The receptionist has a visa, a student loan, and a Macy’s card. She also has a steady income from her paycheck that the millionaire often subsidizes with his own credit and she still drives the Honda she bought with the money she earned from her paper route in High school. The difference is that the receptionist has fewer credit lines to manage, she manages them well, and she has a steady income. But seriously, to which of these two would you loan $100,000 dollars?

FICO is a good attempt to level the field but it does nothing to make the field fair.  No two borrowers are alike but FICO has identified 10 segments of the population and forces all those seeking credit into 10 segments (possibly 12 with FICO ’08).  Essentially, FICO assumes that there are 10 profile types applying for credit. I have to think that 1 out of 10 will surprise you by either by being deemed a good credit risk and defaulting or being a bad credit risk and honoring their debt.  Combined, that’s a 20% margin of error which is hardly good data.

By the way, who says that the FICO scoring system is accurate?  Has Fair Issac or the credit bureaus ever published a statement or year-end report showing that what they predicted actually happened?  Essentially, did their formula replicate what actually happened with defaults, late payers and those who paid according to the term? I would think that if their predictions and corresponding credit scores proved out, they’d broadcast this fact with impunity.

But then again, FICO and the credit bureaus don’t work for the consumer or borrower; they work for the lender. In fact, they use the consumer payment history, sell it to the lender and charge the consumer to see the same report and score they sell to the lender. 

And how come the FICO scoring formula is secret?  It’s supposed to be objective so where’s the need for secrecy? And how come a given consumer doesn’t have the right to know exactly why they have to pay more for a loan or credit line than the next person. 

And with FICO ’08, we will no longer have the ability to improve credit scores by “piggy backing” an account in good standing.  Let me get this straight, FICO relies on input from creditors who consider if a borrower is credit worthy based largely on who has extended them credit.  A piggy bank account means that an individual considers another individual credit worthy enough to be named as an authorized user on their account and, thus, has extended credit.  Isn’t this the same thing, regardless of who offers it?  With FICO ’08, it appears that it is only considered real credit if the creditor submits information to the credit bureaus or pays the credit bureaus for the sharing of information.  This is entirely too self-serving among the credit bureaus and the FICO score to be considered fair.

And the fact that FICO scores and the credit bureaus can unilaterally decide what is and what isn’t fair and thereby give banks the rationale to alter fees and interest based on a self-serving system is akin to price fixing.

FICO and the credit bureaus are rogue entities and unfortunately they have the power to cast the financial future of many unsuspecting consumers.  I’m not suggesting that there is a better method of standardizing the issuance of credit, but I am calling for a certain transparency among those who determine how we gain and what we pay for credit.  Tell us the exact scoring formula and tell us the margin of error with the credit profile predictions—meaning how many defaults and late pays did the credit bureaus predict and how many took place And one more thing, elevate my credit score by the same margin of error.