Representative Maxine Waters recently introduced the Fair Credit Reporting Improvement Act of 2014 to the U.S. Congress, and it's proposing the most ambitious overhaul of credit reporting laws in history. If it passes, the Act would reduce the time derogatory information can sit on your credit report, set more stringent standards for the credit bureaus, and regulate the way credit reports can be used for employment purposes.
However, I can't help but think that the bill may be overreaching. Wouldn't the quicker removal of bad information artificially inflate scores? Doesn't this punish consumers who have played by the rules and built up excellent scores under the current system? And what would the overall effect on U.S. consumers be?
There are definitely some good proposals in the bill; but here's why it may need to be scaled back a bit to be truly for the good of the U.S. and its consumers.
Some good ideas
There are definitely some good points in the proposal that could do a lot of good for consumers. For example, adverse real estate loans, such as foreclosures, would have to be removed if they are determined to be caused by deceptive lending practices, which were happening a lot in the mid 2000s.
The act also would encourage more competition between credit scoring companies. Currently, the FICO score is dominant, and is used in more than 90% of lending decisions. The new regulations would require consumers to be informed that there is "no one credit score," and would entitle consumers to one free credit score annually.
There's also a provision that encourages consumers to shop around for the best rates on mortgages, auto loans, and student loans. Under the act, any of these inquiries that occur within 120 days of each other can only be treated as one inquiry when calculating a credit score. Currently, the window is just 14 or 45 days, depending on which version of the FICO scoring formula is used.
Additionally, the act would require a lot more transparency and investigating on the part of the credit bureaus in the event that a consumer disputes information on his or her credit report.
There are a lot of components to the proposed act, and the full list can be found here.
Bad information will disappear quicker
I start to have an issue with the proposed changes when it comes to the list of information that will come off of credit reports quicker than in the past. Bankruptcies would only remain on your credit for seven years, instead of the current 10. Judgments, paid tax liens, collections, late payments, and other negative information would only remain for four years instead of seven. And any paid or settled debts would have to be removed within 45 days, regardless of how delinquent they were.
Basically, this changes the meaning of a credit score without necessarily changing credit standards to compensate for it. Right now, an excellent credit score implies that a consumer has been very responsible with his or her credit for a certain length of time. By reducing the effective length of the credit history, a high score becomes less meaningful.
Artificially inflated scores are a slippery slope
Consumers who already have excellent credit scores really shouldn't see any major changes in their scores. However, these changes will undoubtedly improve the credit scores for millions of people. And, these higher scores will imply a lower credit risk to lenders than the borrowers have "earned."
Now, these credit scoring changes aren't necessarily bad if lenders raise their standards to compensate; but what are the chances of that happening? The trend has been toward more subprime borrowers, not fewer, and these changes would give lenders justification to lend to many more borrowers who can't qualify for credit under the current credit scoring rules.
For example, let's say that the cutoff for an auto loan is a credit score of 620. Under the proposed changes, meeting this threshold will be easier for many people with spotty credit histories.
Making credit too easy to obtain is simply asking for trouble, as we found out the hard way during the mortgage crisis. The difference this time is that, instead of using deceptive and unfair lending practices, we might just inflate the scores to make a lot of borrowers look more creditworthy.
As I said before, there are some very positive provisions in the legislation. However, the effects on credit defaults need to be carefully considered before these changes are implemented.
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