No Fair Play in the Credit Score Game
While having a strong credit profile is a key component to unlocking the doors of wealth building opportunities, it is important to understand that even with the best personal financial management, credit scoring algorithms appear to disadvantage certain customers.
Hello there, Talking About Money Community, I hope that all is well with you. 🙏🏼
In this post I want to discuss credit scores, and specifically why credit scores are not what they are cracked up to be. Credit scores, invented by Bill Fair and Earl Isaac back in 1958, meant to revolutionize the lending industry, and the advent of the FICO score helped usher in a new, more objective, model for credit scoring, based on an individual’s lending history.
As opposed to when my parents walked into their neighborhood retail bank in 1973, asked for a mortgage loan, and were judged for that loan based on their “character” (whatever that means), in the past decades credit scoring companies have boasted that their algorithms have become more and more precise in predicting the likelihood that a consumer will pay back their debt. Really, do you know me?
I have long been suspicious of credit scores, dating back to my early days in the financial capability field. The older I get, the more dubious I become, and I have questions.
Could credit scores be sexist?
When I was younger, I was very proud of my credit score, in an all-A’s-on-the-report-card kind of way. You may have some students in your financial education workshops who feel this way; I know that I do. When I cover the unit on credit in my first-time homebuyer classes, I often ask the group, “who here is proud of their credit scores?”, and I watch a few eager “Me!” responses appear in the chat box.
That’s great, don’t get me wrong. I am proud of my students who are conscientious about their credit use and are focused on on-time payments and low utilization rates. Good credit management is good financial management, after all.
The first peek I had that the credit scoring arena might be biased was when I was merging finances with my then-new husband. As we linked up our financial lives he told me of his inattention-to-detail in credit matters when he was in his twenties, and how his score bumped around for awhile before the score settled to what it was. Friends, his credit score was higher than mine! How could this have happened, when I was so focused on perfection, and he was seemingly complacent? Huh.
You might have a faint recollection of the Apple Card fiasco of 2019, when the credit scoring algorithm accessing applicants granted much more credit to male applicants than female. Even when those applicants were married partners with combined finances whose applications were identical. Investigations into what happened showed while not seeing the applicant’s gender on the application, the machine noted data that correlates with gender, and downgraded female applicants as a result. Because women were historically granted less credit, the algorithm learned to perpetuate that pattern.
Could credit scores discriminate against you based on situations outside of your control?
Sometimes regardless of how much care and attention you give to your credit score, you cannot win the game. In my homebuyer classes, after I let some of my students glow in the self-satisfaction of their credit scores, I ask the class, “What do you think are the top three reasons for bankruptcy in the United States?” The answers once again cascade into the chat box: “Overspending.” “Mismanagement.” “Death.” “Medical debt. “Medical debt.” “Medical expenses.”
Most of my students are on the right track, as medical debt is indeed the top reason why people file for bankruptcy in the United States, along with job loss and divorce. These consumers may have been doing everything in their power to stay afloat financially, only to get sick or injured and not the have enough health insurance to see them through, leading to cash flow issues, a tanked credit score, and ultimately, bankruptcy.
While not having to do with medical debt – and not leading to bankruptcy – I saw my credit score flop for reasons entirely outside my control. Back in 2008 my second son was born (much to the delight of his two-year-old brother, who was looking for a buddy). I had already commenced my self-employment journey and decided to take a break from seeking out consulting projects so that I could figure out how to manage a two-kid household. My husband, an architect, was to be the sole breadwinner for a few months until I rehung my shingle and went back to work.
Then the fall came, and everything changed. The Great Recession was all over the news, the stock market was mayhem, and uncertainty abounded. Construction came to a grinding halt, and pretty soon, my husband’s firm announced that they were commencing layoffs, and the remaining staff would be reduced to a four-day workweek and 80% compensation.
My husband was one of the lucky ones and kept his job, but at 80% salary for him and 0% income for me, we were in a pickle. How were we going to support a household and pay a mortgage on this reduced income? Luckily, along came the Home Affordable Modification Program and we were able to modify our mortgage and save $300/month in mortgage payments, allowing us to squeak by until I could resume work. And it came at a cost: Our credit score immediately plunged 100+ points and it took us five years to regain what we had lost.
Could credit scores be racist?
The more I work with students in financial education workshops and the more credit report and scores that I see, the more confused I get as to why the information on one credit report correlates to a specific score. There does not seem to be much rhyme or reason. And this could be why – “noisy data.”
In an article on Nextgov, there is bias in credit scoring, but not in the AI (artificial intelligence) that you may assume causes it. Instead, researchers found that consumers with a “thin file” (fewer active trade lines) resulted in lower scores because the credit scoring algorithms like more data, not less. If you think about it in terms of fractions, one blemish on your credit file when you only have two trade lines is much more impactful than if you have one blemish on six trade lines. Overall, the study found that low-income and minority borrowers had credit scores that were less accurate in predictors of defaulting on a loan, leading to more loan denials.
But there’s more. In the article by Michael Harriot called “Is Credit Racist,” the original credit score formulated by Fair and Isaac sought to answer not the credit seeker’s ability to pay, but rather a more obtuse question—will the customer choose to pay? What kind of question is that?
While there are several factors and pieces of data that contribute to different proprietary credit scores, those algorithms are secret (like the formulas of Coca Cola and Kentucky Fried Chicken) so you are not going to know exactly what caused your credit score to go up or down. Furthermore, you are not allowed to challenge your credit score, so what you see is what you get.
What to do about this? Some community banks will place more emphasis in the underwriting process on the actual information in the credit report rather than fixating solely on the 3-digit number. There are pilot projects in the works to factor in payment histories on recurring expenses like rent and utilities with the hopes that timely payments will drive credit scores up. And financial capability practitioners like you can continue to educate your communities on the ins and outs of credit, how to dispute inaccuracies on their credit reports, and how to advocate for themselves to attain the highest score that they can.
Because in the end, this game is not fair and yet we are forced to play.