Understanding Fair Isaac and the Fair Credit Reporting Act

lend borrowBack in grade school, teachers routinely terrorized misbehaving students with the threat that their misconduct would “go down on your permanent record.”  I envisioned my “permanent record” as something of a huge book, where entries were printed neatly by vindictive teachers wielding their bloody red fountain pens, later to be pored over by some Big Superintendent in the Sky, detailing every transgression of my grade school and high school careers.  It’s a terrifying myth, long-remembered.

Now that there are several decades separating me and my permanent record, it no longer keeps me awake at night.  However, childhood worries are often replaced by adult worries:  one such creator of anxiety, even more damning than your “permanent record,” is the Credit Score.

We’re All Being Tracked

As much as we would all like to think that we possess the privacy and solitude that was commonplace in our nation’s pre-industrial past, it simply doesn’t exist anymore.  Our entire planet is inexorably bound together by electronics, microscopic digital pathways that function in myriad ways over optic cable and the airwaves: from our cell phones pinging off a tower and disclosing our location to our computers keeping track of our every keystroke, to maps created from space that can peer directly into the birdbaths in our backyards.

We are observed by video cameras at every intersection, in every parking lot and drive thru; Google tracks you; Facebook tracks you.  So do banks, credit card companies, credit unions and every other company with money to lend.  It’s business. And it’s big.

What the Heck is a Credit Score?

The three major businesses that track credit worthiness are Experian, TransUnion and Equifax.  Remember these names because they are the ones to whom you go to obtain and correct, if necessary, your own credit information.

Banks make money by selling money.  The cost of the sale is called “interest.”  If the lender doesn’t recover his principal or interest, he loses.  If the lender intends to make money, it is incumbent upon him to lend only to those individuals who will very likely pay the debt.  They need a way to determine if you are a good credit risk.  To do this, most lenders use FICO (not to be confused with FIDO, which is usually a dog).

Introducing Fair Isaac, aka FICO

FICO is the mathematical formula used to create the three digit number that is your credit score. FICO was developed in the 1980s by the Fair Isaac COrporation.  As a result, the score is referred to as a “FICO” score, an acronym for its developer. Any FICO score consists of several components, much like your high school report card.  There are five categories that are weighted according to their relative importance.  All five factors are considered predictive of whether you will repay money loaned to you.  In other words, the FICO score assesses your credit risk.  Banks, credit unions and credit card issuers routinely rely on this number when credit decisions are made.

The most heavily weighted factor is your payment history, accounting for 35% of the total, followed by how much debt you already have, which accounts for 30%.  The remaining factors are how long you have had credit (15%), whether you have recently opened new credit accounts (10% negative), and the type of credit you currently have (10%).

The FICO formula produces a credit score range of 500 to 850.

Here’s Why Your Credit Score Matters

Now, an example:  Your 1980 Chevette is burning oil, the bumpers have been missing since 1986 and recently, a strange odor has started to permeate the cabin when you make a right turn.  You need a new car.

When you visit your local dealership, you find the perfect vehicle.  It is a left over from a previous model year, but has only 5 miles on it.  Okay, the car is a rather nauseating shade of mauve and the seats are black leatherette, but a fashionista you ain’t.  The salesman, who hasn’t had a sale all month, is desperate.  So you pick up your snazzy mauve ride with a spoiler in the back for a cool 15 grand, license and tax included.

Of course you don’t have 15 grand buried under the house anywhere, so you will need to borrow some money.  You visit your friendly neighborhood bank.  They run your credit score.  Hurray!  Your score is 800!  You have always been diligent about paying your bills and never lived above your means.  Your 32-year-old Chevette is testament to that fact.

The bank will be happy to lend you the money.  But how much interest will the bank want?  Because your credit score is so good, the bank will offer you a favorable rate.  You are considered a good risk. You could easily borrow money from the bank’s competitor.  They want your business because they are pretty darn sure they will make money on your loan.

How Your Score Impacts the Bottom Line

So they offer to finance your car for 6% per annum. Over the life of a 36-month loan, which you wisely opted for, you will pay a total of $17,865, making the cost of interest $2,865.  Had your credit score been below 589, your interest rate would likely be 18 ½%.  In that case, the total cost of the same loan would be $24,960 and interest would account for $9,960 of the total.  The total cost of the same car is $7,095 less with an excellent credit rating than with a poor one.

So there is real money involved from the application of FICO.  That’s why your credit score is worth tending and monitoring.  So now Lil’ Bo Peep, what tools can you use to look after your credit garden?  There are some pretty good ones.  Read on.

Know Your Rights Regarding Credit Reports

Because of the importance of credit scores to lenders and borrowers, and to ensure the integrity of credit reporters, Congress enacted the Fair Credit Reporting Act (FCRA) in 1970.  The FCRA confers numerous rights on consumers that are detailed at the Federal Trade Commission website.

Those rights are important, because as we have seen, different credit scores can significantly affect both your ability to obtain credit and its cost.

The FCRA entitles you to know whether information in your credit file has been used against you in obtaining credit, insurance or employment.  Should you receive notice of a negative use of your credit, you are entitled to a free copy of the report upon which the adverse action was based.  You have the right to dispute incomplete or inaccurate information.  You must do so in writing.

Obtaining Your Free Reports

Under regular circumstances, the FCRA gives you a right to a free copy of your credit report from all three credit reporting agencies once every 12 months.  You can order your copy directly from the FTC.  There are imposters that offer this service, but they will charge you for it.  Just get it through the FTC to avoid this ripoff.

You can use your free copies to correct incomplete or inaccurate items listed.  If your non-payment of a bill was the source of a bona fide dispute, the fact that you disputed the charges cannot be held against you.

A regular check of your credit report can help you defend yourself against identity theft. If credit inquiries were made by creditors you never heard of, someone may have designs on your credit.  As Barney Fife would say, this is the time to “nip it nip it nip it”!

Out with the Old!

You have a right to have outdated information purged from your credit files.  Negative credit reports over seven years old must be purged from your file.  Make sure they are.  Bankruptcies are reportable for 10 years after filing, but these are often not removed by the credit reporter.  If yours is more than 10 years old, request its removal.  It simply should not be there after 10 years.  Items warranting removal from your credit file must be cleared by the credit reporting agency within 30 days of notification, unless it determines that the information reported is accurate and reportable.

Now that you have met Fair Isaac, are acquainted with the basics of the FCRA, and have learned how to protect your credit reputation, don’t forget the two most basic lessons of all:  The best way to look after your credit score is to (1) pay your bills on time and (2) live within your means.

Karen L. Stewart is a 1986 graduate of the University of Louisville Brandeis School of Law, a former staff attorney in the U.S. Bankruptcy Court and an experienced civil litigator in both trial and appellate work. She is licensed to practice law in Kentucky and Wisconsin and in several federal jurisdictions.

Disclaimer: The comments made in this blog are for general informational purposes only, do not constitute specific legal advice and do not create an attorney-client relationship. Please contact your attorney if you need specific legal advice or representation.

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