What you bought is not what it you think it is…

If you have ever felt confused by credit scores, don’t feel alone!  Everywhere you go from the internet, to television ads, to radio commercials you will see some type of product that you can purchase to learn your “credit score”.  All kinds of companies are now making a big push to have us as consumer’s purchase our credit scores so that we are aware of what is being reported about us.  While I can appreciate the awareness that this brings to people about the importance of our credit score, the part that really irritates me is that all these companies are really doing is confusing people even more. 

                Just about every time I do a public speaking event I have someone bring up an example and it usually is always about the same.  It goes like this, “I checked my score online, then I went to a mortgage broker and was shocked when I was told that my score was significantly lower than the score I just bought a day or two earlier online, why is that?”  The answer that I give is always the same; the score you bought online is a credit score.  It is considered a credit score because it does take the information from your credit report, evaluates it somehow and then gives you some type of credit that reflects your creditworthiness.  That is where the similarities end and confusion begins!  The main difference is just about every “credit score” you purchase online has two main differences from the FICO score.  First, usually it has a different score range, for example in the classic FICO score the range is 300 to 850.  Some of these other scores have ranges from 500 to 950! The second main difference is the criterion that is being analyzed.  FICO has certain things they use in their model and each of those has different values.  These other scores can’t use the same values as FICO does so for that reason not only do they have a different score range, they also evaluate different information and assign different values to that information. 

                Having said all that, at this point in time the FICO score is the overwhelmingly favorite score used by all industries to determine your creditworthiness.  So unless that changes, in my opinion it is a waste of time to spend any money to see what a score looks like or follow any advice to improve that score if it’s not even a score that any lender is ever going to use anyhow to determine if you can qualify for a loan or not.

                A lot of people understand the difference between a “credit score” and FICO score, but one other thing that can drive people nuts is when they do their homework and are educated about the differences so they purchase their FICO score on the internet.  They are doing the right thing by at least purchasing the proper type of score, but then again are surprised when the scenario above is played out again.  How can this happen, “I pulled my FICO score, my mortgage person also pulled my FICO score but there is a big difference between what I pulled and the score the mortgage broker pulled?”  What we are dealing with here is FICO has created not only industry specific scoring models, but also there are different versions of that model being used!  Currently there are over 49 legitimate FICO scores being used all with differences between each of them.  In other words depending on what type of credit you are applying for and who you are applying with you could have 49 different FICO scores!

                The best advice I can give you with this, understand the best you can what the FICO score is looking for and evaluating, then do the best you can to maximize all those areas of your score.

“Joint credit”…what does it really mean?

The world of joint credit can be a little confusing.  Mainly because there are different types of joint credit and each one carries a different list of circumstances and responsibilities.  Before you enter into the world of joint credit with another person, it will be helpful if you know exactly what you might be agreeing to.   Here is a list of some very important things you need to know before agreeing to any type of joint credit.

1.       There are multiple types of shared credit.

Many people use the term “joint credit” but depending on the bank or lender’s opinion that can mean a lot of very different things.  There are three different types of shared credit.  They are:

Joint Credit: With this agreement you are a full partner on the account. You filled out or at least signed a credit application.  

What you might not know: With this type of account you are 100% responsible for the bill (not 50 percent).

Authorized User: You are able to use the credit, but you have basically no financial liability to repay the debt.  You never filled out or signed an application.  Someone else filled out the application, obtained the credit and is responsible for the repayment of the debt; they just gave you charging privileges.

What you might not know:  If the account holder doesn’t pay, some lenders may try to come after you for the charges that you were responsible for.

Co-signer: You are signing to be responsible for the entire bill, but the loan or credit account is in someone else’s name and you can’t use it.  The other person will receive the bills, and you may or may not have access to account information. 

What you may not know: If the person that you co-signed for defaults,  pays late or misses a payment, that information can be included in your credit history!

2.       How joint debt is reported on your credit report.

Understand there is no such thing as a joint credit history.  This means the entire account history and balance of the account appears fully on your credit report.  It is not broken up to only show what you are responsible for.  This means it doesn’t matter who makes the charge or who was responsible for a late payment, both parties are responsible and their credit report will both fully reflect those actions.

3.       Divorce courts can’t reassign joint debts.

Two spouses that have multiple joint credit accounts will have to decide who will be financially responsible for each one of those debts.  This is a stipulation that is rendered by the divorce courts as part of that process.  It however does not change the view of the account with the creditors.  Even though the court says one party is responsible financially for a debt, if that person fails to pay, the other person is still liable.  A credit card agreement is between the borrower and the lender, and divorce courts don’t have the authority to alter that agreement.  

4.       With joint credit both people are affected equally.

If a joint credit account is good (low balances, paid off in full, high credit limit, no late payments), it helps all the parties involved.  But if it’s not healthy (late payments, rolling balances, maxed out credit line), everybody’s credit suffers.

Final advice: be careful when it comes to joint credit.  Make sure you understand all the potential ramifications associated with your involvement in the account before you agree to anything.   

Is it time for change?

In the past few months many people are publicly taking the stance that the FICO scoring system needs to be changed.  The claim is that adjustments need to be made to the existing formula to better reflect the current economic landscape.  Most of these people think the system is outdated and should be changed to lessen the value that is placed on credit card balances compared to the limit on those cards and that an occasional late payment or a collection should not have as big of an impact as it currently does.  They believe that if these changes were made that it would increase the average credit score of Americans which would then help the economy because more people would be able to qualify for things that they currently are unable to purchase. 

                All that sounds like a great idea but there are a few reasons as to why this is very flawed thinking.  The first thing that needs to be understood is FICO is a company that developed a product to make money.  Their customers are primarily lenders and banks.  Not American consumers.  We do not increase their profits.  Their main asset that makes their entire business run is the formula that they have created, tested, analyzed and developed know as the FICO score.  If you owned a very lucrative business and your main customer had no complaints with your product would you completely change your product for a few that didn’t like it?

                The next point lost by those waiving the banner for change is, what is the purpose of the FICO score in the first place?  If you don’t actually know what the product is designed to do in the first place, it makes it hard to make an educated comment that it should just be changed.  The purpose of the FICO score is predict the statistical chance of a consumer being 90 days late or more in the next 2 years on a loan/credit card obligation.  The key word is “predict”.   Having years of data and millions of samples as the foundation for their product evidently is not enough for some people.  If they change things just too arbitrarily inflate people’s scores all they would do is make their product less valuable and end up upsetting their main customer base in the process.  It will never happen and in my opinion there is no need too, the product does what it is supposed to do.  I am not a FICO score apologist, but in this case the argument made publicly by many is one that is not properly thought out and being made to the wrong people.  If you really want change, and the basis for change is that more people need to be able to qualify for loans.  Then the outcry needs to be directed at banks, and more importantly the credit reporting agencies.  The FICO score is only as good as the data that it has to analyze.  The problem isn’t the score; the problem is the people reporting to the bureaus and the bureaus themselves!  Credit bureaus make money by storing and selling data.  Nowhere in that statement did I say “accurate” data.  In dealing with credit bureaus on a daily basis I do not believe the accuracy of the data is a very high concern of theirs.  If it was they would do several things differently!

                Don’t hold your breath waiting for people to make FICO tweak their model to better reflect the current economic challenges, that isn’t going to happen.  A better use of your effort would be to direct it towards the credit bureaus who have sloppy reporting and find as many ways possible to not really help consumers that have inaccurate or unverifiable items on their credit report.

Big mortgage changes are happening...or maybe not!

Watching the Federal Housing Administration try to change their guidelines over the last few months reminds me of a bad movie where a random person is mistaken for a trained Police Officer. Then thrown out in the middle of a busy intersection and expected to direct traffic. The person tries their best but after several “go, stop, wait, slowdowns and ut oh’s” we are left with a 50 car pileup and a huge mess to clean up. Let’s take a look at how they have done so far and what the proposed changes have been.

In late February, they announced they were set to go ahead with new changes effective April 1^st, 2012. The main issues that were to be affected by these new rules were “disputed accounts” and unpaid collections, Profit & loss accounts and charged off accounts. The highlights of this first proposed change that was if the total outstanding balances of ALL disputed accounts and ALL collection, P&L and charged off accounts regardless of age, is $1,000 or greater, the account must be:

· Verified as not a debt to the borrower; OR

• In a repayment arrangement with a minimum 3 months of verified payments documented as paid as agreed and those payments included in the borrower’s debt-to-income ratios; OR

• Paid in full, prior to, or at the time of closing.

After this bold stance they came back around the start of April with a slight “slowdown” and made a few concessions. Here is the summary of those changes;

• P&L, charged off and repossession accounts will NOT be considered collection accounts or subject to the guidance of the new changes

• Borrowers will be exempt from the new rules if the disputed collection with an aggregate amount of $1,000 or greater was a result of “life events” such as medical, death, divorce, loss of employment, etc. may be acceptable as long as the borrower provides a written explanation AND documentation.

Also in this set of updates if the credit report reveals that the borrower is disputing any credit accounts, there will be additional restrictions placed on that persons ability to qualify for an FHA loan unless;

• The total outstanding balance of all disputed accounts are less than $1,000 AND

• Disputed accounts are aged no less than two years from the date of last activity as indicated on the most recent credit report.

Now it is time for the “ut oh” just before the 50 car pileup took place…they announced the latest set of changes have now been postponed until July 1^st!

Watching this unfold, one is left scratching their head. It is just another classic case of people making decisions about something they really don’t know anything about in the first place and having no clue at how massive the ripple effect of a terrible change like this might be.

By restricting people’s ability to “dispute” inaccurate, unverifiable or outdated accounts on their credit report , FHA is basically taking the stance that the credit bureaus rarely make a mistake and they are deeply concerned about the accuracy of what they report on a persons credit report. The problem with that stance is it’s been estimated that roughly 79% of credit reports have serious errors on them! Not exactly a number that says the system is so good that we can actually strip consumers of their rights to have an accurate report.

This bit about if a collection is more recent than two years old based on the date of last activity then it falls into these new guidelines, just might be the biggest joke of all in my mind. Let me preface, I am not making an opinion about whether the collection needs to be paid or not, I am committing on the method that will be used to determine if it needs to be paid. The date of last activity is supposed to reflect the last time a payment was made on the account or new terms were agreed to. The problem with this is most collection companies know as much about this as FHA apparently knows about credit reporting. Collection companies already falsely update this date all the time. What do you think will happen once they realize that as long as they keep updating this date, the chance of them collecting on this debt is astronomically higher? I’m going to make a prediction that a lot of collection companies will just make this normal business practice and always update that date on a monthly basis.

If these rules come into play, the big winners will be collection companies and credit bureaus. If that was FHA’s goal when they threw out these changes, then mission accomplished. Let’s hope this waiting period is one that will help FHA realize their changes will completely miss the mark of what they are trying to accomplish!

Why is 50 points such a big deal?

Just about everyone understands that your credit score is a very important number when it comes to your financial livelihood, but have you ever thought to understand why? The purpose of the FICO score is to predict the statistical chance of a consumer being 90 days late or more in the next two years. But more importantly let’s take a look at categorically how this breaks down in the eyes of your potential lender.

Below is a chart that indicates the odds of a consumer becoming 90 days late or more.

Score	Odds
800 & above	1%
750 to 799	2%
700 to 749	5%
650 to 699	14%
600 to 649	31%
550 to 599	51%
500 to 549	70%
Below 500	89%

Here is a real world example of how this chart works. Let’s assume that two people come to you and ask to borrow $5,000 from you. The only difference is that one person has a FICO score of 740 and the other has a score of a 549. How long would it take you to decide who you would give the money too? Understand the person with a 549 score means there is a 70% chance that person will be 90 days late or more in the next two years vs. the person with the 740 who has only a 2% chance of being late! Do you think that if you decided to lend your money to both people that you might have different rates and or fees between the two loans?

I understand the credit scoring process can be frustrating and very complicated, but the purpose of the system is very clear. It is all about predictive information for the purposes of lenders deciding who to lend money too and with what terms.

Based on this chart you can see how critical a few points can be, in some instances it means over a 50% less chance of being 90 days late or more depending on the score.