The Credit Score Glitch

Everyone relies on FICO - but there are glitches. We have noted before the lenders choice of reporting and coding can actually have a bigger impact in your credit score than the actual activity by a consumer. For instance a short sale can have a bigger impact than a foreclosure depending on how things are coded. This seems to make no sense. Now we learn that banks randomly deciding to close inactive accounts or trying to reduce exposure so they lower the amount available. This can drive down a person's credit score through no fault of the borrower.

So a lenders arbitrary decisions - that have nothing to do with the lenders activity, influence or decisions can have a huge impact and possibly affect things like jobs, rental decisions, and everything in between. Then we hear that credit scores are basically a black hole determined by Fair Issac and a few others. This gets pretty scary how much how company - not really accountable or regulated can have on a person's life.

This article from the USA Today shows how the falling economy is revealing some of the problems of the current credit scoring procedures. The article is titled Sliding economy raises questions about credit scores. They may not be the most respected news organization in the country, but we have to acknowledge the good investigative reporting USA Today has done on the credit crisis. Not lets take a look at the article -

Banks and lenders are shoring up risks — closing a record number of credit card accounts and reducing millions of dollars in credit lines. As they clamp down, even some consumers with excellent credit and spotless payment records are seeing their credit scores reduced because of the diminished credit lines. That, in turn, can hamper consumers' ability to get credit elsewhere.

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The cycle concerns consumer advocates and some legislators. Some wonder whether restrictions should be imposed on lenders' ability to slash credit limits and close accounts. And if scores can drop even if consumers do nothing wrong, they say, it raises the question of whether there's a flaw in the credit scoring formulas relied upon by the nation's lenders, insurers, and increasingly employers and landlords.

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Bank officials also say they have no control over credit score calculations — and, like consumers, they don't know exactly how such scores are determined.

"It's tough to connect any one action (by the lender) to consumers' credit score," says Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, which represents large banks.

Even so, banks are concerned enough about the issue that they've asked Fair Isaac, the creator of the widely used FICO score, to study whether — and to what extent — their tightening of credit affects scores. Fair Isaac plans to complete its preliminary study in the next few weeks.

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Seth J. Chandler, a law professor at the University of Houston, says although credit scores are "incredibly powerful, lenders might start to revise the importance they put on (them) if they no longer reflect reality."

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Fair Isaac and the credit bureaus don't disclose exactly how credit scores are calculated. But a key factor in the score is what the industry calls "open to buy," basically how much of a consumer's credit line is drawn down on plastic. Also called the credit utilization ratio, this — along with a handful of other variables — makes up a combined 30% of your FICO score, Fair Isaac says. Other important components include overall payment history, how long a consumer has had credit, and the types of credit.

When lenders close accounts or slash credit limits, it often boosts the percentage of available credit consumers are using. That's the key reason scores could fall.

We have given a huge amount of control to one company. The article further states that -

Today, 90 of the largest 100 financial institutions rely on FICO scores, according to Fair Isaac. Credit bureaus also sell proprietary credit scores, and team up to put out the VantageScore, a competitor to FICO.

FICO has a lot of control. While there is little control and understanding about how credit scores are derived. Yes we know the basics, but even bankers acknowledge they do not know the specifics.

Imagine how much damage and problems FICO has can have on the country if something goes wrong. Could one lethal computer virus at FICO could damage the country? Or the financial World? When we are seeing the havoc a few large companies can have when they dominate the markets, it is surprising there is not more regulatory pressure on FICO.

Perhaps this USA Today article will help bring some guidelines, industry wide procedures for something that affects so many but is only understood and controlled by a few.

Just when we thought things could not get any scarier, they do.