We have all heard the catchy FreeCreditReport.com jingles on TV, but have we really stopped to think about how credit information is used and how it is dividing the country? Due mainly to the recent fiscal crisis, 25 percent of Americans had low credit scores in April 2010, compared to a historical average of 15 percent.
The Fair Credit Reporting Act (FCRA) entitles everyone to receive one free credit report a year. Yet, for-profit sites, such as Freecreditreport.com, with its catchy jingle and commercials, claim to be free but are not. Only the website annualcreditreport.com actually provides free credit reports as required under the law.
A credit report, however, is not the same as a credit score. A credit report lays out your financial history, loans you have taken out, credit cards in your name, and details about your payment history and whether you have filed for bankruptcy, been sued, or had a foreclosure. A credit score, on the other hand, is the number assigned to you that represents your riskiness for repayment. Credit scores typically range from 300 to 850; the higher the number, the lower the credit risk a consumer is considered. And while a consumer is entitled to one free credit report a year under FCRA, the FCRA does not entitle you to a copy of your credit score, what lenders base their lending decisions on, for free. New rules implementing credit score disclosure requirements under the Dodd-Frank Act, which became effective on July 28th, will enable consumers who are denied credit or offered a higher-than-usual interest rate to find out the reasons by getting a free look at their credit scores. The regulations require financial institutions to send consumers a free copy of their credit score with factors that have decreased their score when they aren’t given the best loan terms and lowest rates after applying for a credit card or a home loan. Yet, this isn’t the same as simply receiving a free score once a year as is the case with your credit report. The Credit Score Fairness Act, which has been introduced in previous sessions of Congress, would have changed this and entitled to consumers to free copies of both their credit report and credit scores, but Congress has yet to pass this legislation.
This is regrettable for several reasons. First, the current credit reporting system is fraught with inaccuracies. A 2008 Federal Trade Commission (FTC)-sponsored pilot study found that about 31 percent of people who reviewed their credit report found errors that they wanted to dispute. Unfortunately most people find out about inaccuracies after they have already been negatively affected. Moreover, the process of disputing the errors can be timely and costly to consumers. Easier access to both credit reports and scores, would allow people to catch errors earlier thereby avoiding credit score markdowns and harmful repercussions that arise from low scores.
Second, the use of credit information and credit checks has expanded beyond its original purpose. According to Fair Isaac Corporation, the company that pioneered credit scores, a credit score is an “objective measurement of your credit risk” for such things as car and home loans. In other words, credit scores were originally intended to be used solely as a representation of a consumer’s likelihood of repaying a loan. Yet, credit reports and scores are being increasingly used by landlords, insurance companies, utility companies and, most notably, by employers. A January 2010 survey conducted by the Society for Human Resource Management found that 60 percent of companies use credit reports to inform hiring decisions, up from 24 percent in 2004. This new phenomena has become a catch-22—people need a job to get credit, but they can’t get a job if they have bad credit or no credit at all. How are people supposed to climb out of poverty if they are not able to gain employment and work towards improving their credit in order to obtain assets? Five states, including Illinois, have recognized this problem and have banned the use of credit checks by employers for hiring and firing decisions, and 22 more states are considering similar legislation.
Another problem with credit scores is that they appear to be contributing to the already widening national racial wealth divide. There has been evidence that some companies have used credit checks as a way to discriminate against minorities by using these checks to preclude minority workers from getting higher level jobs. For example, the Department of Labor won a case against Bank of America in which the bank was found to have discriminated against African-Americans by using credit checks to hire entry-level employees. Similarly, a recent study done by the Woodstock Institute looked at zip codes and consumers’ average credit scores. The study showed that predominately African-American communities were almost four times as likely to have individuals with credit scores in the lowest range as predominantly white communities. Individuals with lower credit scores have a harder time acquiring loans for homes, cars, accessing credit cards and other low cost loan products, leaving them less likely to attain assets.
Finally, what about the estimated 50 to 70 million Americans who have no credit score at all? Given the prominence, both good and bad, that credit scores and reports are playing our lives, this segment of the population lacks the key (i.e., credit score) to the mainstream financial industry. If alternative credit data, such as paying rent, utility bills and medical bills on time were included in the data reported to credit bureaus, un-scored consumers could be brought into the credit industry. Unfortunately, those who are un- or underscored are most likely to forego paying things like utility bills to pay for food instead. If this information were included although they would have a credit report and credit score, it would most likely be a bad score. The question of how to best serve this population still remains, but some credit reporting agencies, such as Experian, have begun reporting the use of rental data in its calculation of consumers’ credit scores. Whether this will benefit or hurt consumers has yet to be seen, especially since Experian will also report delinquent rental payments.
In sum, policy makers and advocates need to consider the preeminence of credit reports and scores in recent years, the effect on consumers of these changes, and to ensure that consumers are adequately protected.
This blog post was coauthored by Ali Terkel.