Our Flawed Credit Reporting System

As a company, FaithWorks Financial tends to keep the focus on helping people resolve their credit card debts and get back on track to living a debt-free life. Only a small portion of our writings cover the topic of the credit report, mostly touching on the basics that are helpful for everyone to know.

Today, however, we would like to take a look at why we believe that our credit reporting system is, in its inherent nature, flawed.

The FICO credit reporting system is the primary resource used by lenders to determine an individual’s creditworthiness. This system is what was historically used by “the big three” Equifax, TransUnion, and Experian. In recent years, however, other systems such as Vantage 3.0 are very gaining in popularity. What this means is that you may have a different score even from the same credit bureau, depending on the system used to procure your score.

As FICO is the more traditional of credit scoring systems, we’ll share a very helpful image from myfico.com that will help you to understand what your FICO credit score consists of.

As you can see, 35% of your credit score is based on your payment history, 30% is based on the amounts that you owe, 15% is based on the length of credit history, 10% on new credit, and 10% on the types of credit that you use.

The one thing that every single one of these sections has in common is that they are based on your use of credit. That means that 100% of your credit score is determined by how you use the debt that is made available to you.

This is similar across all reporting systems, so the mechanics remain the same from one system to the next.

Forced To Make Poor Financial Decisions

Thinking back to when I was a young 18-year-old man with a very limited understanding of how the credit system worked, I found it very difficult for myself to obtain a credit card. Did I need a credit card? Well, probably not. But it just seemed like a very important thing for me to do, a rite of passage, if you will. Truth be told, this was likely due to the wonderful job the banks did with their marketing campaigns.

Knowing now what lenders are looking at before they decide whether or not to issue a line of credit, I very much understand why it was so difficult for me to obtain a credit card at that point in my life… I had not yet established myself as being a creditworthy individual.

I was not yet in debt, so how could I be trusted to be in debt?

So, this experience taught me that in order to be considered eligible for a line of credit you first must find yourself in debt. That’s a conundrum right there.

My inability to get a credit card led to the eventual necessary purchase of a vehicle with a 24.99% interest rate from a buy-here-pay-here auto dealer. That loan led to my being approved for my first credit card – an HSBC account with a $300 credit limit and a 29.9% interest rate. The two powers combined allowed me to begin establishing my credibility as a consumer.

I mention that brief story because I could not be eligible for credit without first putting myself into debt by means of that incredibly high interest auto loan.

Had I not been blessed with a fair paying job at the right time, I would likely have found myself upside down on that auto loan which could have lead to a disastrous credit report before even having the chance to get my financial life started properly.

The truth is, most young adults find themselves in the same or similar situations. We have to make a poor financial decision in order to build our credit. Or, worse yet, a person without established credit would have to expect someone else to make a poor financial decision by cosigning for them.

In some instances, parents help their children begin to establish credit at a young age, which may benefit their credit scores, but only at the high risk of jeopardizing the parents’ scores to begin with. Otherwise, the process of obtaining your first line of credit will often come from an experience such as mine or possibly from student loan debt that ultimately costs more than your degree is worth.

If the credit reporting system had taken a look at my timely payment history on my cell phone, utility bills, rent, and other obligations, it may have been clear that I had a good track record with my financial obligations. But our credit reporting systems are driven by putting individuals into debt.

It demands that you make high risk (and ultimately poor) decisions in order to be considered eligible for a reasonable loan in the future. Add in the recent news that some of the bureaus are themselves violating the Fair Credit Reporting Act, and we see that the entire credit reporting system is inherently flawed.

In working with our clients, we have found that for the young individuals that come to us for help, that initial loan is very often what puts individuals into a downward spiral with their personal finances to begin with.

Promoting The Cycle Of Debt

Even individuals who are incredibly diligent about maintaining a stellar credit history, working towards the ultimate goal of paying off their credit cards, their auto loan, and eventually even their mortgage, can be penalized as a result of this flawed system.

An individual who brings themselves to a phenomenal 850 credit score rating by means of “proper” credit card use and timely payments on installment loans such as their car and mortgage, can have their credit score quickly dwindle upon paying off their debts.

Anybody who reaches the goal of what should be the American dream- a debt-free life, having finally paid off their mortgage and the car- will eventually find themselves with a credit score lower than if they were up to the hilt in debt.

A Wide Reach, A Wider Impact

Aside from this very clear and obvious flaw in the credit reporting system, it has become very evident that the system is not even capable of furnishing accurate information about the individuals it is reporting on. According to a February 2013 press release (there do not seem to be any updates to this study), the Federal Trade Commission reported that 5% of consumers identified errors on their credit reports that would negatively affect their credit scores. This may not be a huge percentage, but a report by Business Insider dives much deeper on just what those numbers mean.

There is no way to say just how much the inaccurate information contained in credit reports has cost Americans in higher interest or denied loans, but certainly, the number would be staggering to learn. And frankly, even if it weren’t staggering, it is simply unacceptable.

I look at credit reports on a near-daily basis, and I can sometimes even spot the inaccuracies without even knowing anything about the individual’s circumstances. Inaccuracies in name spellings and addresses are a dime a dozen and are generally blatantly incorrect. Seemingly small errors such as an incorrect name can lead to much bigger issues such as when a woman adopted the identity of the person she purchased a home from! These instances are examples of the lack of oversight of such an important matter.

In fact, I’ve seen enough errors on reports that it was the sole reason my wife and I didn’t name our firstborn son after me, as I know it is very common for Jr’s and Sr’s to get their credit reports commingled.

Considering the fact that this reporting system is the very basis for the vast majority of lending decisions, it is simply frightening that it is acceptable for it not to be working 100% seamlessly. If a company is going to undertake the responsibility of providing information on credit histories to lenders, the should be checks and balances in place to ensure that the information provided is factual.

Who Will Guard The Guards?

“Quis custodiet ipsos custodes?”- a beautiful and unsuspectingly deep latin phrase translating to “Who will guard the guards?”

The FTC, Congress, and the consumer financial protection Bureau all have this very important matter on their radar. As individuals forced into this system, we too need to take action by ensuring that our reports are accurate and disputing inaccurate remarks. If you need help with your credit report, let us know.

Even better, let’s contact our state representatives and lawmakers to urge them to find a way to make a difference to overhaul this flawed system.