If you buy a car, rent an apartment, open an account with a utility, or even face sentencing in front of a judge, someone’s going to pull your credit report. Scores of “soft inquiries” can be made without permission, while “hard inquiries” that affect your credit report happen when you authorize a credit check for the purpose of granting a loan, establishing an account, or some other business activity. But how valid is the credit scoring system, and should we really be relying upon it as a system for establishing financial risk, especially in light of the multi-billion dollar online industry surrounding consumer credit?
Credit agencies compile a variety of information about any individual with open lines of credit, from student loans to car leases to, until recently, medical debt. Financial institutions can deny assistance to people with “bad” credit, and credit is also checked in housing, employment, and other settings, some of which might be argued as discriminatory—does bad credit make someone unemployable? Does a single eviction on a credit report in years of flawless rental records mean that someone can’t be trusted to make rent?
With the recent news that FICO, the nation’s most widely used credit scoring system, is readjusting its algorithm to address the pervasive issue of medical debt dragging down credit scores, some industry professionals are concerned. The widely heralded move that some see as a removal of punishments for medical expenses could backfire, argues Fiscal Times correspondent Rob Garver. Garver warns, “The worst-case scenario is that the new scores will result in many consumers getting loans they shouldn’t, landing in serious financial trouble.” How useful is a scoring system that even lenders don’t trust?
According to a Federal Trade Commission study, over a quarter of people surveyed found errors on their credit reports, and struggled to have them corrected. While Experian, Equifax, and TransUnion—the big three credit reporting agencies—are obliged to keep careful records and update credit reports when customers file a complaint, many are sluggish to fix consumer credit reports. That can result in an artificially low credit score—and corresponding problems accessing funds.
Since most people don’t bother to check their credit until they’re getting ready to apply for credit or preparing for a major life event—or in the event funding is denied on the grounds of bad credit—the need to fix errors quickly is rather imperative. Credit bureaus can afford to be sluggish, though, as the almighty FICO score determines access to the mainstream economy—and those with poor credit are pushed to the shadowy and unregulated “fourth bureau,” an amalgamation of firms that collect information with no oversight and no controls.
Such firms harvest a variety of personal data with no restrictions, and data once considered less relevant or helpful is now becoming integral to credit evaluations—with no opportunities for customers to appeal erroneous information. Much of that data comes from an obvious source: Online activity. It’s not just which catalogs you order. It’s your online spending activity, where you go, which social networks you belong to, and who you associate with.
The fourth bureau takes advantage of nebulous privacy policies and unaware consumers who don’t take advantage of opt-out policies (yet another argument for opt-in policies as a default) to collect copious volumes of personal financial information. That information is in turn bought, sold, and traded with other firms, all without the consumer’s awareness or ability to intervene if the information is wrong.
This has a huge impact on individual consumer credit and the lives of people seeking access to banking services in the U.S. If information from the fourth bureau is incorrect, people may not be able to qualify for even the most basic of loans, and can be excluded from jobs, housing opportunities, and even volunteer possibilities. With no means for countering the information gathered through digital means and sold by such bureaus to whoever wants to pay for it, consumers are left with their backs against the wall.
And the situation isn’t much better when it comes to more legitimate credit services.
Under law, the three major credit companies are required to provide a copy of a consumer’s credit report, free of charge, annually; AnnualCreditReport.com acts as the FTC’s only authorized clearinghouse to allow consumers to readily access and request copies of their credit reports—something people should be doing annually or in advance of major events in order to be aware of what’s on their records. The site was founded not only to facilitate consumer access to their own credit history, but also to address the growing industry of sites preying on consumers desperately seeking information about their credit.
While the situation on Google has gotten better, a consumer searching for “free credit report” will be directed to a myriad of sites that demand payment—whether for subscription services, viewing a credit report, or credit advice. Freecreditreport.com, for example, charges $1 for basic services—and starts auto-charging your card $14.99 per month if you don’t cancel your subscription. Users are enticed to sign up for services like “credit monitoring” on such sites, which promise that for a low, low fee, they’ll protect consumers from adverse credit events.
Aside from the fact that credit reports can actually be obtained for free through the three major credit bureaus (and that a savvy consumer can stagger requests to check in once every four months), the “services” advertised are available for free, through easier means, and often from better quality sources.
For example, a growing number of banks and credit unions offer credit monitoring and protection free or at low charge in association with member accounts, just as credit card companies do—and not just on their elite member cards. Thus, consumers are duped into paying for services they don’t need through predatory firms that take advantage of the nebulousness of information on the Internet (as well as the widespread financial illiteracy in the United States).
Speaking to USA Today, Georgetown professor Annamaria Lusardi noted: “If we live in a world where people are in charge of their own financial well-being…we have to equip people to deal with this individual responsibility…Not everybody is given an opportunity (at home) to be financially literate. This is a topic that should be in the schools.”
A lack of understanding about financial matters makes it extremely difficult for individual consumers to spot practices like exploitative credit monitoring services, let alone more serious issues, like predatory lending. The financial industry has long taken advantage of this, and so do firms targeting worried and confused consumers with the Internet as a massive field of opportunity.
While the record collection and reporting system may have originally been designed as a means for assessing financial risk, it’s clearly outdated and potentially dangerous for consumers. Even with the FTC’s attempts to stay ahead of abuses of consumer credit, the agency is woefully behind, a common issue with government agencies and the digital revolution. The incredibly fast pace of digital developments makes it extremely difficult for legislators and regulatory officials alike to keep pace with, let alone anticipate, new developments in the financial industry as elsewhere.
The results can mean bad news for consumers, but it’s also bad news for the financial industry, which really does need a valid way to establish credit risk. When the financial industry is already a Wild West atmosphere, why make it worse?
Photo via Credit Confidential/Flickr (CC BY N.D.-2.0)