In this week's mortgage news, credit reporting agency TransUnion announced a change in its "CreditVision" scoring product. The new system, claims the company, makes it possible to score roughly 26.5 million consumers who previously could not be scored.
The Rich Get Richer
But wait; there's more.
With its new scoring tool, says TransUnion, the percentage of borrowers in the "super prime" category increased from 12 percent to 21 percent. In practical terms, what this means is that a prime borrower, who already has access to some of the better mortgage rates available, may get an upgrade to "super prime" and be offered the lowest possible mortgage rates.
Can Your Score Increase?
But how about you? Can your credit score be higher? Mortgage lenders typically pull three scores for every prospective borrower. They then use the middle score to qualify the borrower for financing. The higher the score the lower the rate.
This all seems neat and tidy until we dig a little deeper. If there are three scores, and if the three scores come from the same data, then why are they different?
The answer to these questions involves very big money, some of which is yours.
A number of companies provide credit scores and the goal of each system is to reduce lender risk and future losses. This is done by looking at past credit use and then predicting how borrowers will behave in the future.
Data Comes from Creditor, not Credit Bureaus
There are several hurdles credit scoring firms try to overcome.
The data measured by credit scores -- the stuff in credit reports -- must be accurate, and credit bureaus are only as accurate as the creditors that report to them. Experian claims it processes 45 million business records a day.
This is a problem because according to the Federal Trade Commission, one in 20 credit reports has an error that can reduce scores by at least 25 points. For a relatively few borrowers, the error problem is even more significant: their reports are so littered with mistakes that scores can be unfairly knocked down by 100 points or more -- enough to not just justify a higher mortgage rate but result in a complete loan denial.
While the odds of a credit report error are small, if it happens to you it becomes very important. This is the reason that credit reports should be checked regularly to purge out-of-date items and factually-incorrect entries.
Bureaus Determine Penalties
The values given for various measures such as the length an account is outstanding or the percentage of credit used must reflect real-world repayment practices. Here the question is one of judgment: how many points is a late payment worth? Is a late payment for a car loan equal to the value assigned to the late payment for an unpaid hospital bill?
Judgment issues are always in flux. For instance, last year, one of the largest credit scoring companies announced that it will give less value to medical bills, thus increasing many scores by 25 points.
Many Scores, Many Results
The credit scores you see, whether you pay for them at the government's www.annualcredit report.com or get them free from LendingTree.com, are not always the same scores used by lenders. Credit analysts have estimated that a consumer might have 49 FICO scores!
The reason for this is that Fair, Isaac Corporation – the company that created the FICO score – came up with the basic formula used to mash up consumer credit data for all kinds of loan types. This data is collected by the three major credit reporting agencies (CRAs) Equifax, Experian and TransUnion, and analyzed by FICO to create a single, three-digit score. Because the three CRAs don't necessarily have exactly the same information reported to them (not every creditor reports to all three agencies), there are three versions of this basic score.
FICO has created several other versions of their basic score, customized for different types of creditors – there are versions for auto financing, mortgage lending, credit cards and insurance. So that's three basics scores, four industry-specific variations and three CRAs – you're already up to 15 scores. In addition, there are different versions. FICO continually circles back to evaluate the effectiveness of its scoring as a predictor of consumer payment behavior. It then uses its results to update the formulas. So even creditors using the same industry-specific variation of the FICO score might be using different models and getting different scores.
Where Does this Leave Mr. and Ms. Consumer?
Lenders, of course, have a choice of credit scoring systems and may use or not use a given product. For borrowers, what this means is that you need to shop around, to deal with the lender who can deliver the best possible rates and terms, a mortgage made possible in part by using the credit scoring system which works best for you.