The Shriver Brief : Poverty Law Commentary & Insights : Sargent Shriver National Center on Poverty Law : Affordable Housing, Healthcare Reform

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 28^th, 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.

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Experian aims to bring millions of Americans into the mainstream credit market by incorporating rental data into credit reports. RentBureau, which Experian acquired last June, is the largest collector of rental payment data. It collects and reports rental data from property management companies nationwide so lessors can screen potential tenants. Experian’s announcement earlier this month that it will include positive rental data is being billed as a new way for the estimated 50 million unbanked consumers to build credit. 

Credit scores have increasingly become a key factor in families’ ability to acquire assets. Credit scores are used to determine whether or not a family can get a loan to buy a home or a car, start a business, fund post-secondary education, or even obtain a credit card. Employers are also starting to use credit scores in the hiring process to screen applicants. Thus, a thin credit file or a low credit score can prevent families from acquiring the assets that lead to economic mobility.

For these reasons, consumer advocates, credit analysts, and lenders have been exploring different options for calculating credit-worthiness. The reporting of nontraditional or alternative credit data has frequently been suggested as one of these options. Since traditional data, such as credit cards, mortgages, and student loans, are not typically available for lower income families, the use of nontraditional data, such as utility bills, mobile phone bills, and rental payments, is viewed as a means of incorporating these individuals into the credit reporting industry. For example, one third of people in the United States are renters and now, like mortgage owners, their payment histories will affect their credit scores.

Yet, there is much debate as to whether the inclusion of nontraditional credit data will be helpful or harmful to low-income and credit-thin families. Some argue that such reporting will catapult previously excluded families into the mainstream lending market, allowing them to access the credit needed to build assets. Others argue that alternative reporting could prove to be harmful and be used to further marginalize low-income families. If, for example, a family must choose between paying for groceries or paying the light bill most families will choose groceries, thereby negatively affecting their credit scores. The Shriver Center addressed this issue in-depth in the Clearinghouse Review article,Alternative Credit Data: To Report or Not to Report, That is the Question, and facilitated a discussion of industry experts in a webinar, Credit Scoring and the Un-Scored: Alternative Credit Data.

Although, Experian’s announcement highlights the fact that its use of positive rental data in its calculation of consumers’ FICO scores “will … help many renters who are looking for ways to rebuild their credit scores due to financial hardships such as a foreclosure or a bankruptcy,” it omits the fact that in 2012 Experian will also begin reporting negative data (i.e., missed payments). Reporting such negative data will most certainly push those same families struggling to recover from foreclosure and bankruptcy out of their rental homes.

To be financially stable members of the U.S. economy, families must have access to credit. It remains to be seen whether reporting alternative data is the appropriate way to ensure low-income and asset-poor families’ successful entry into the mainstream credit industry. One thing for certain is that Experian’s so-called concern for those ”recovering from financial hardship” is not all that it seems. 

Kelly Ward coauthored this blog post.

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House and Senate negotiators have finally agreed to language for the Dodd-Frank bill, now headed back to both chambers for approval. Of the many reforms that the bill’s passage would initiate, one change of particular interest to consumers, which is receiving little attention, is the credit score access provision.

While consumers are entitled to one free credit report per year from each of the big three agencies, there currently are no mechanisms for receiving a copy of your credit score, the number that is meant to represent credit worthiness, at no cost. The Dodd-Frank bill would allow consumers free access to their credit score if their score negatively affects them in a financial transaction or a hiring decision. In particular, the law would allow consumers to request credit score disclosures as part of receiving an adverse action or risk-based pricing notice.

This is a good start, but there is another bill that would provide even stronger protections. H.R. 2374 would amend the Fair Credit Reporting Act to make credit scores available to consumers once each year free of charge and allow consumers to see the credit score used in connection with any of the lending or credit decisions made on their behalf. This would expand access to credit scores to all transactions, rather than limiting it to those transactions in which a person was negatively affected by their score.

What makes access to a credit score at no-cost so important? Since credit scores have become vital to accessing the credit necessary to build assets, people should have easy access to their scores before they apply for a loan or credit card. Fees for accessing credit scores are a burden that falls disproportionately on lower-income families. Knowing a score beforehand can help consumers plan for the annual percentage rate (APR) they will likely be eligible for, take steps to repair their score if necessary, and avoid unnecessarily high interest rates. Freddie Mac estimated that more than 20% of people who received sub-prime loans could have qualified for less-expensive prime loans.

Access to a no-cost annual credit score is not a silver bullet. It does not address the needs of the nearly 70 million people who have no credit scores or a thin file score. Attention still needs to be paid to how to bring this population into the mainstream credit market, whether through alternative data reporting or other means. In the meantime, this is at least a step toward making the credit reporting system more accessible and transparent.
 

Hannah Weinberger-Divack coauthored this post.

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In the last 25 years, credit has taken on an increasingly important role in our economy. Yet, an estimated 50 to 70 million Americans remain un-scored or have a thin credit file, meaning that the big three U.S. credit bureaus (TransUnion, Experian and Equifax) do not have enough information about these individuals' finances to assign them a credit score, whether good or bad. Accumulating assets is necessary for low-income families to move out of asset poverty and become financially secure. 

Without a credit history, it is difficult, if not impossible, to qualify for a mortgage, obtain a credit card, buy a car, or finance a small business. Increasingly, even employment and rental housing decisions hinge on a credit score. These computer-generated scores have, in just a couple of decades, become the benchmark for lending. Banks use credit scores to determine eligibility and pricing for loans. Although banks argue that standardization of credit scoring has enabled millions of consumers to get loans quickly and at a low price, without regard to race, gender, or residence, estimates indicate that 32 million consumers have credit files that are too thin to score, and 22 million have no files at all. Many of the “un” or “under” scored are minorities, young adults, and women.

Most credit scores are based on some variation of Fair Isaac's FICO score, which ranges from 300 to 850. The lower the score, the greater the risk. The main factors used in a FICO score are payment history for credit cards, mortgages, and other retail accounts, the amount a consumer owes, the length of time he or she has held credit, and the amount of recently opened credit cards. In order to increase access to credit, some advocates are calling for the inclusion of  alternative data in credit reporting.

A 2006 study indicated that an overwhelming majority of lenders believe that increasing numbers of individuals could borrow money if nontraditional data were incorporated into lending decisions. In fact, half of the lenders interviewed in this study said that they were already using or evaluating the use of alternative data sources. Yet, a closer look at the credit reporting system seems appropriate before incorporating such data. 

If, as some claim, the current credit system’s lack of transparency and inaccuracy already discriminates against low-income families, should we first work on making the credit bureaus accountable and transparent before adding more information into a seemingly vacuous and obscure system? If a new reporting system is needed, how should it be constructed so that minorities and low-income workers do not become even more vulnerable?

Moreover, not all alternate credit reporting and scoring methodologies are created equal. What types of data predict creditworthiness and should therefore be reported? Should it be limited to data such as rent, telecom, and utility payments? Should alternative data reporting also include things such as child care, medical, and other payments not currently or routinely examined by the large credit-reporting agencies? As part of incorporating such alternative data, should the reporting process be adjusted to provide an opt-in for those who want it, rather than automatic reporting for all? Or should extra weight be given to payments, such as child support, thereby making credit scoring not only a predictor of creditworthiness, but also a basis for social policy?

The Shriver Center is hosting a webinar to explore the effect alternative data reporting will have on low-income families. Join us on May 27th at 1 p.m. CDT to learn about current research on the impact of alternative data reporting based on firms that already report both on-time and late payment, including full data reporting of NICOR and DTE customers; current gas and electric utility credit and collection data from states around the country; the National Credit Reporting Association’s perspective on alternative credit reporting, and proposed legislative amendments to the Fair Credit Reporting Act.

This article was coauthored by Susan Ritacca.

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