by John Ulzheimer
Discussion of credit scores is what the media call a “lightning rod” topic, which means it always elicits strong opinions. Normally those opinions are unfairly critical of credit scores. But, would we be better off without credit scores?
Some consumers actually live the reality of not having credit scores. Their credit files do not contain enough data for scoring systems to work their magic and calculate a reliable prediction of how likely they are to pay their bills in the future. This is referred to as “minimum scoring criteria,” and it means credit files must meet some minimum standards in order to qualify for a score. If you don’t have a credit score, then you can’t enjoy its benefits.
Do you remember the days when getting a loan took months? Those days were before today’s environment of “instant credit.” The tool that helps to facilitate instant credit is, in fact, the credit score.
A credit score is a simple 3-digit interpretation of the information on your credit reports. The higher the number, the better your credit risk and the more attractive you become to lenders. Not having a credit score means you cannot be “processed” by a lender’s automated application systems and you must be decisioned manually.
Manual underwriting isn’t the end of the world, but it’s certainly much more time consuming. You’re asking a human being to review your credit report, which contains too little information to yield a score, and to render a judgment about what kind of credit risk you pose to his or her bank. That’s a tall task to ask of anyone, even for the most seasoned underwriter or risk manager.
Having a credit score gives you access to more competitively priced financial services and products. For example, I just opened a new checking account with a credit union. The credit union has a policy of checking the credit score of every prospective member, so it pulled my credit report and credit score. Because of my good credit score I was able to open the account.
Now with this account I can cash checks, write checks, and build wealth in such a way that my deposit is likely to be entirely insured by the federal government. I also get overdraft protection, whereby the credit union automatically lends me the money to cover checks or card transactions that exceed my available balance. (Overdrawing an account is something no one should do, so I don’t ever plan to use that service, but it is included with the account.)
The alternative to a mainstream checking account? Using check-cashing stores, prepaid debit cards and hoarding cash in your home. These options are more expensive and, frankly, dangerous. They do nothing to help you build wealth.
Credit scores also remove the human element from the risk assessment process and provide for a more fair and empirical evaluation of your credit reports. This is important because what you consider to be risky in a consumer may not be risky at all, empirically.
Case in point: Is a credit report that is devoid of derogatory information reflective of good credit risk or poor credit risk? I believe any reasonably prudent person would say the lack of negative information means the consumer is a good credit risk, and they might be correct. However, the absence of derogatory information is only worth about one-third of the points in your credit score. The remaining two-thirds have nothing to do with whether or not you pay your bills on time. Debt measurements, inquiries, the age of your credit report, and the diversity of your account history all tell a very important story about your credit risk yet they’re difficult to properly interpret without the help of a credit scoring model.