Learning The Score

If you have a financial life, you have a grade, and everybody knows it but you. For years the credit-reporting industry has been reducing consumers' credit reports to numerical scores, and lenders have been using these scores to decide whether to approve loans and how much to charge for them. The credit industry says the scores make lenders more impartial and efficient, but consumers couldn't see their scores unless they begged a sympathetic lender to spill the beans.

The scores mean serious money, and so does the secrecy. The difference between a high and low score can mean eight percentage points, or almost $5,000 in added interest payments on a five-year, $15,000 car loan, estimates E-Loan's CEO, Chris Larsen. Consumers waste more than $100 million every year in interest on overpriced loans aimed at less qualified borrowers because they don't know their own scores, says Sen. Charles E. Schumer (Democrat of New York).

Now, the industry is about to throw open its grade book, albeit grudgingly. A new California law says the credit scorers will have to be ready to provide consumers with their own grades by July 1, 2001, but pressure from Congress and a variety of consumer and lending groups may make national disclosure a reality in the next few months. Fair, Isaac & Co., the San Rafael, Calif., company that invented the mathematical formulas used in credit scoring and that produces the most widely used, eponymous FICO score, took a first step last week by explaining the scores to lenders, so they could then convey them to customers. The firm plans to make individual scores available to consumers by year-end through Equifax and Experian, two of the Big Three credit-reporting bureaus that license its software. The third, TransUnion, is readying its own scores for release.

These scores are more important than ever. The FICO is used to determine consumer creditworthiness for about 80 percent of all mortgages, as well as in car loans, credit cards and even some insurance policies and apartment-rental contracts. It's a three-digit number, ranging from about 350 to 900, that each credit bureau constructs for itself by plugging consumer-credit-report data into the Fair, Isaac software. Equifax calls its score Beacon, TransUnion uses Empirica and Experian calls its score Experian/ Fair, Isaac. Six out of 10 consumers have scores topping 700; anything below that can cause problems.

Newsweek subscription offers >

It's not just the numbers, but the secret formula that produces them that counts. Not wanting to give away the keys to its profit center, and worried that informed consumers will try to manipulate the system, Fair, Isaac has worked to keep its black box a secret. "They act like it's a matter of national security," says Greg Fisher, a mortgage broker who got so disgusted with scoring's clandestine power that he created a comprehensive Web site, creditscoring.com, to shed light on the subject.

Now that Fair, Isaac is starting to shed its own light, there are almost as many questions raised as answered. The firm has revealed its list of some 30 factors that go into the scores, but much of the information remains vague. For example, the firm discloses that the number of credit cards held will affect a borrower's score, but does not reveal how many cards are the right number. Other factors that can hurt a score include the presence of new credit cards and the absence of car loans.

Scoring critics are troubled even by the little information they do have. Finance-company loans can lower a score, but they may be the only source of loans for low- and moderate-income borrowers. Other negatives, like lots of credit inquiries and no recent revolving balances, seem to punish those who chase teaser rates or pay off balances without paying interest, and may be measuring profitability more than creditworthiness. Fair, Isaac has fixed its formula to eliminate some problems. It consolidates credit inquiries that come close together to avoid penalizing comparison shoppers, and recently agreed not to treat prior use of credit counseling as a negative.

The firm will keep the game, but borrowers will learn to play. Consumers who ask enough car dealers or mortgage lenders can probably get their scores today, says Fisher. The only way to "fix" scores is the hard way, by building a solid history of paying bills on time, all the time, and scrubbing mistakes from your credit report.

Newsweek subscription offers >

But some short-term strategies may work, too. Because credit scores are constantly updated, it's never too late to do a little cosmetic work. Racing to pay down some debts before applying for a mortgage can help. Consumers juggling more than 10 credit cards may decide to cancel a few, but don't cancel all of them. It actually helps to keep a couple of inactive cards, explains mortgage broker Ginny Ferguson. A customer with five cards, each with a $5,000 limit, who has a balance of $4,000 on one of them will have a better credit score than the customer with one $4,000 balance on a single $5,000 card. The first one is using 16 percent of available credit; the second one is using 80 percent.

There's also some evidence that keeping a small balance on cards is better than no balance at all, and it probably pays to look average. Fair, Isaac finds seven cards and four other loans in the average portfolio.

There's no going back to the days of eye contact and handshakes, recalled fondly by wistful mortgage brokers like Tucson's James Kenny. "We used to call underwriting an art, instead of a science," he says. "Now we take living, breathing people and break them down into a number." The credit industry already has yours. It's time for you to get it, too.

Learning The Score | News