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Improve Credit Score Transparency or Risk Another Financial Crisis

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Credit scores are vitally important in many areas of your financial life, ranging from getting loans and credit cards to saving on insurance rates, finding an apartment, or even getting your next job. Because of their importance, it's essential to improve credit score transparency to the point at which everyday borrowers will not only know where they stand on their credit but the reasons why their credit scores rise and fall over time.

What we do know
Credit-reporting agencies aren't entirely opaque about what goes into their credit score calculations. For instance, Fair Isaac (NYSE: FICO  ) , the company behind the popular FICO score, offers a detailed explanation of what goes into every person's score. A strong payment history without delinquencies or late payments carries the most weight, making up 35% of the FICO score, while 30% comes from how the amounts you owe compare to the total credit you have available to you. Smaller percentages of the score come from other areas, including the length of your credit history, the amount of new credit you've taken out recently, and how wide a mix of different types of credit you have outstanding.

Fair Isaac is also upfront about what it doesn't consider in its scoring. Legally protected information like race, religion, or marital status can't be used to determine credit scores, and Fair Isaac chooses not to consider age, employment history, where you live, or whether you're in a credit-counseling program, among other things.

Other bureaus have their own scores, such as the VantageScore product from Experian, TransUnion, and Equifax (NYSE: EFX  ) . VantageScore uses its own categories, with payment histories getting a 32% weight, credit availability and use 23%, total debt 15%, length of credit history 13%, recent credit history and inquiries 10%, and available credit 7%.

These formulas make the scoring process seem extremely complicated, giving only a glimpse at the overall process of coming up with a credit score. Exactly what goes into the point total is still a mystery, hidden as proprietary trade secrets of the companies involved.

Why you need to know
The reason that credit-reporting bureaus need to improve credit score transparency is that in some cases, every point counts. Consider:

  • In the mortgage loan arena, big lenders Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , and Wells Fargo (NYSE: WFC  ) have had to rein in their credit standards substantially in the aftermath of the financial crisis, as bank regulators want to ensure that the events that brought the financial system to the brink of collapse never repeat. As a result, single points that push you above or below key credit-score thresholds are instrumental in determining whether you'll be able to buy the home you want and get financing at a fair rate.
  • In other areas, it's even less clear what your credit score means. For instance, in employment situations, just coming up with a baseline threshold is itself a matter of subjective judgment. Without the details on exactly where you stand on your score, you might never know that you didn't get a job because of your credit history.

Perhaps most important, keeping score calculations secret and relying on the credit-reporting bureaus to act as guardians of credit ratings puts a huge amount of responsibility on their shoulders. With many documented cases of erroneous credit-history information being used to calculate these scores, it's naive to take on faith that the resulting scores are correct -- yet there's currently no way to see exactly how an erroneous piece of information actually has a direct impact on your credit score.

Don't give up
A decade ago, having free access to a credit report seemed like a pipe dream, yet legislation now makes such disclosures mandatory on an annual basis. With the same drive and determination, consumers can demand that credit-reporting agencies improve credit score transparency to the point at which everyone will understand the ins and outs of the key financial metrics governing their financial lives.

Making the right financial decisions today makes a world of difference in your golden years, but with most people chronically under-saving for retirement, it's clear not enough is being done. Don't make the same mistakes as the masses. Learn about The Shocking Can't-Miss Truth About Your Retirement. It won't cost you a thing, but don't wait, because your free report won't be available forever.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.


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  • Report this Comment On June 26, 2013, at 10:25 AM, WalterGeorge wrote:

    Awesome article. Here is my take. The credit system is a scam that hurts and endangers many children nation wide. After the recession millions upon millions of peoples credit scores took a hit. Now they can't get safe places to live for their children, they can barely afford to fix it cause we just don't make enough any more. Housing went up, food went up, gas went up, electric went up, water went up but the one thing that didn't go up are our wages. They actually went down. Some people such as myself had great jobs for a while. So we did what society tells us we should do. We purchased houses, we purchased cars and such trusting that we could repay it. Then people got greedy, their need for excess endangered jobs and caused a collapse. Negam loans to squeeze as much out of people as possible. It became everyone for themselves no holds bard all that matters is money and being above and beyond the person standing next to you. Investments were being stolen in the form of bonuses to executives, hard working peoples lives were wiped right out from under them and then they were called lazy when they wouldn't take jobs that would cover their debts and still allow them to live. Heck they are still called lazy when they wont take jobs that wont even cover the cost of living. The balance is way out of wack and its only preparing us for another bubble where the greater portion of the people taking the largest hit. The portion that borrows the most just to survive. $14 an hour just doesn't cut it these days. Especially with student loans, rent rates, electric rates, water rates, the jobs required reliable transportation, rising costs of gas, rising costs of food, rising costs of all products. Funny thing is all these costs are rising but wages on average are not. A society living on credit is what you get and eventually since the wages are below the costs you hit a brick wall where there is no more money to make it up, it was eaten up by the same very people we work for instead of reinvested into our system creating stability. 427% above and beyond the average may be the breaking point. It's not allowing enough real currency to run through the system to generate true real wealth only more and more debts. This need to be envied and to have a system driven by greed only leads to one thing. Eventually the same as it was hundreds of years ago when monarchies roamed the earth. You will eventually have kings and a bunch of slaves indebted to them. Our system was not suppose to be that way. Its only one sided success and its completely unsustainable. Especially since our economy is based off supply and demand and the ability to consume. How can small business grow when people can't consume? Small business can't create a credit based system such as Wal-Mart or Dillars and such. They rely on people actually being able to afford goods. Or what happens is what is happening today. Wages are not covering consumption so consumption is going on credit with the hope that wages will continue to cover it when you work for people who are 100% ready to send a job to China. If I was a lender I wouldn't lend anything at all. Not one person that has a job or works for someone else can honestly tell me they can pay it back. Its not up to them, its up to the morals and values of the people he or she works for. Do they value money more then people and if they do how long before they sell out their own for the money?

  • Report this Comment On June 26, 2013, at 10:39 AM, blackfalcon59 wrote:

    Transparency is always a good thing. However, that's not the only problem here. One of the two biggest problems with the recovery of the housing market right now, ( yes, the reported recovery is definitely phony), is that the pool of qualified buyers has been cut in half over the last 5 years due to credit issues resulting from long term job loss, major medical costs, etc...Most of these people are good hard working individuals who may now have recovered from the employment problem, but are still plagued by the crooked FICO score game due to circumstances they had no control over to begin with. We need to have this credit reporting system torn down and rebuilt with a fair structure that takes into account all the negative life circumstances that can kill a good person's credit. No more waiting periods for mortgages and no reporting of negaitive items until they have been disputed and verified. I have a very common last name and have had many items removed from my credit reports that didn't belong there. The current system was created of the banks, by the banks, and for the banks! It should be outlawed and replaced with a consumer friendly system that helps keep our economy moving; not one that prolongs the agony.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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