April 20, 2020
It’s no secret that the credit scoring models used to generate your credit scores were created for a purpose. The original purpose was to determine the likelihood of having a 90-day late payment within the next two years. Clearly, credit scores are inadequate to achieve this purpose.
They don’t take into account any of the other factors that could cause someone to be late on any payments. For example, they don’t include any data on your income, savings account, the condition of the business or industry you are part of, inflation, the economy or anything else other than your accounts that are reported to the credit bureaus.
And even if the 90-day late prediction is still the stated reason for their existence, there is much more to the use and manipulation of credit scores now than was ever stated when they came into existence.
The problem is that the scores are arbitrary. Algorithms have been created and changed over time that affect credit scores. Within these algorithms there are things that cause scores to go up and down when certain things happen. For example, opening a new account can cause your score to go down. Closing an account can also cause your score to go down.
But new accounts, in spite of these algorithms, do not always increase the likelihood of you being 90 days late on an account. How about when you open a new account so you can get the money needed to increase your income? That should decrease the likelihood of you getting behind on your bills.
There are tons of other examples I could use to show that the system is flawed. It isn’t hard to show.
The big question is, who benefits from lower credit scores?
There are two main groups who benefit, plus one large company. The two groups are credit reporting bureaus and banks. The large company is Fair Isaac, the creators of your credit scores.
Here’s how they benefit. When you have a high credit score and a clean report, you decide to buy something on credit and you are given that credit with low rates and good terms. In most instances, your credit is pulled once then you buy.
But when you have bad credit or even fair credit, it doesn’t work the same way. Often, you try to buy something on credit but need to check multiple places, either because you were turned down or because the rate and terms weren’t what you wanted.
Using an example I have seen often, late’s say you are looking for a mortgage and get turned down at your bank after credit has been pulled. Then you go to a mortgage broker who pulls your credit. Even if he can do the loan, the lender he uses will normally pull credit too. Sometimes, the broker can’t do the loan and the you have to check with someone else.
Eventually, you end up having your credit pulled 3 times, maybe more. And every time your credit is pulled, Fair Issac and the credit bureaus make money. In this case, they have made at least 3 times as much money as they would have if you had been approved by the first place you applied.
Let’s go over how the banks profit from lower credit scores. It’s really very simple, if you have an 800 score, you pay the lowest rates. If your score is a bit lower but still pretty good, you might pay a little more. But if your score is bad, your interest rates will be significantly higher.
In short, the higher your credit score, the less money is made by banks, credit bureaus and Fair Isaac. The lower your score, the more money they make.
The way to combat this and pay less for credit is to learn how your credit score is created and take the steps necessary to improve your scores, putting you into a stronger bargaining position.
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