The credit reporting industry may have flaws, but it’s one we’re more or less stuck with.
Equifax
EFX,
one of the three main credit bureaus, sent faulty scores to millions of lenders, resulting in higher interest rates and denied applications, the Wall Street Journal reported this week. This follows a data breach by the same company in 2017 that exposed the personal information of 147 million people.
When credit bureaus report erroneous information about an individual, it potentially hampers that person’s ability to buy or rent a home, get an auto loan, open a new credit card, and even determines the rate they get on their insurance.
Given the credit agencies’ central role in Americans’ daily lives, it’s an extremely high-stakes operation.
“Experian, Equifax, and TransUnion keep files on around 200 million adults and more than 1.6 billion credit accounts”
Presently, the big three credit bureaus, Experian
EXPGY,
Equifax, and TransUnion
TRU,
keep files on around 200 million adults and more than 1.6 billion credit accounts, the Consumer Financial Protection Bureau said.
The government watchdog earlier this year released a report criticizing how the big three responded to consumer complaints, calling them an “oligopoly” that has “little incentive to treat consumers fairly when their credit reports have errors.”
Regarding the Equifax breach, the company said in a statement that it took errors in data “very seriously” and added that it was a “technology coding issue” between March 17 and April 6 that has since been fixed.
“As part of this extensive analysis, we have determined that there was no shift in the vast majority of scores during the three-week timeframe of the issue,” Equifax said. “For those consumers that did experience a score shift, initial analysis indicates that only a small number of them may have received a different credit decision.”
“Our data shows that less than 300,000 consumers experienced a score shift of 25 points or more,” it added. “While the score may have shifted, a score shift does not necessarily mean that a consumer’s credit decision was negatively impacted. We are collaborating with our customers to determine the actual impact to consumers.”
The three credit bureaus did not respond to MarketWatch’s request for comment regarding the CFPB’s categorization.
Alternative credit-score models
Several startups are coming up with alternative credit scoring models using artificial intelligence and data from your smartphone to extrapolate a borrower’s likelihood of repaying a loan. Your digital footprint could also be used for predicting consumer trustworthiness, according to a a 2018 study conducted by the Frankfurt School of Finance & Management.
But it’s hard to come up with an alternative model that covers millions of people over a sufficient period of time, and in an equitable and consistent manner.
Using income to assess creditworthiness is likely to work better for smaller loans, Mingli Zhong, an economist at the Urban Institute, told MarketWatch.
“But for mortgages or auto laws, these are large financial transactions, so I don’t think income is a very good measure,” Zhong explained, “because it’s less stable than your credit histories and your total savings and assets.”
Periods of recession could lead to you being laid off, which means you have $0 in steady income, yet your ability to repay loans may not change if you’re able to pick up odd jobs, for instance.
“‘Lenders are very comfortable with this way of doing things, and it would take a lot to make them change their minds.’”
Additionally, creating an alternative system to the existing credit scoring method requires a deep understanding of each adult’s individual and household wealth, Zhong said, such as how much they have in their savings and checking accounts.
“That is usually challenging in the United States because people would like to protect their privacy,” Zhong said. “They don’t want to disclose all their wealth. That’s probably the reason why we have the credit scoring system, to kind of have a proxy of how much money people have.”
The current method of credit scoring is also mostly an equalizer, Ted Rossman, senior industry analyst at Bankrate.com, told MarketWatch.
Like standardized testing in schools, the existing system is a “useful way to put all applicants on the same scale,” he explained. Plus, it’s something that’s been done for a long time.
“I can’t see the industry moving away from it anytime soon. Lenders are very comfortable with this way of doing things, and it would take a lot to make them change their minds,” Rossman added. “They trust the process. Mortgage lending is particularly regulated and would be among the hardest to change.”
Ultimately, having more competition could backfire, given how sensitive some of this financial information is.
“If we have more agencies, there would be more risk that our Social Security numbers will be leaked,” Zhong said.
But Zhong conceded that the existing credit-score system has been a longstanding impediment for immigrants who are trying to buy a home or take out a car loan.
“It’s far from perfect,” he said.
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