The Big Problem With Credit Scores — Transcript

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1. 0:01America runs on credit.
2. 0:03The three-digit score represents how likely a person is to pay his or her
3. 0:07bills, and it impacts almost every aspect of an American's financial life.
4. 0:12It's like your passport into everything that you need to do as an adult.
5. 0:18And it affects so many things, not just access to credit, so your ability to get
6. 0:21a credit card, a mortgage, a reasonable car loan.
7. 0:26Landlords use credit reports and credit scores, so it'll affect your ability to
8. 0:30get an apartment. Insurance companies use them.
9. 0:33Having a low or no credit score can have severe financial consequences.
10. 0:3842% of Americans said that their credit scores prevented them from accessing
11. 0:42financial products like credit cards or loans.
12. 0:45Life can become more expensive and more difficult as your credit score falls.
13. 0:50But some credit experts argue that the current credit reporting and scoring
14. 0:54systems have major issues.
15. 0:56The current credit scoring system as it stands is flawed.
16. 1:01And this error of being fundamentally misaligned has huge ramifications across
17. 1:06the system for millions of Americans.
18. 1:09Others say many of these criticisms are misguided.
19. 1:12The reality is that the credit reporting system that we have here in the United
20. 1:16States is sort of like the crown jewel of the world.
21. 1:20A lot of the criticisms are based on some fundamental misunderstanding of how
22. 1:25credit scores are calculated and how they're used.
23. 1:28If you take a moment to not be knee-jerk angry about financial
24. 1:32services for a minute, then I think a reasonable person would have to conclude
25. 1:35that these are actually good for consumers relative to a world without
26. 1:40credit scores and what that would mean to our bottom lines.
27. 1:43So how do credit scores work in America and do they help or hurt consumers?
28. 1:54A credit score usually refers to a number between 300 and 850, which
29. 1:59represents the holder's financial stability and creditworthiness.
30. 2:03The higher the number, the better a consumer looks to potential lenders.
31. 2:07Credit scores in the 500s are considered to be very bad.
32. 2:10Credit scores in the 600s, we're starting to use terms like subprime,
33. 2:15near-prime, getting close to average.
34. 2:18But you really need to get yourself into the 700s before you actually hit
35. 2:21the national average, which is between 710 and 720.
36. 2:25And then start working your way into the elite level scores, which are well into
37. 2:29the 700s and certainly into the 800s.
38. 2:32Credit scores and reports are two separate things.
39. 2:36Reports refer to statements containing information about your credit
40. 2:39situation, while scores are calculated based on that information from the
41. 2:43report.
42. 2:44The credit report is like the test you took.
43. 2:47The credit score is the grade you got on the test.
44. 2:49One is influential over the other, but they're not the same thing.
45. 2:53Today, scores calculated by Fair Isaac Corp or FICO have become the industry
46. 2:58standard, used by 90% of top lenders.
47. 3:01They're calculated using five main categories: 35% from payment history,
48. 3:0630% from the amount owed, 15% from the length of credit history, and 10% for
49. 3:11new credit and the types of credit you have.
50. 3:13It's based on an analytic algorithm.
51. 3:16So we look at actual data patterns to say what helps us predict
52. 3:21whether you're going to pay credit in the future.
53. 3:27One of the main benefits of having a credit score is that it provides a quick
54. 3:31and empirically sound method of measuring creditworthiness.
55. 3:34Americans are borrowing today more than ever, with household debt topping $16
56. 3:39trillion during the second quarter of 2022, making credit scores crucial to
57. 3:44many businesses.
58. 3:45It allows lenders to make very, very precise decisions and have a very deep
59. 3:51understanding of the likelihood of someone paying you back.
60. 3:54Experts say that such a streamlined process is also the reason why Americans
61. 3:59have been able to enjoy low-interest rates for so many years.
62. 4:02The credit scoring system allows the industry to quickly and cheaply
63. 4:08make decisions about whether or not you're going to have credit.
64. 4:11The cheaper it is for the lender to decide whether or not they're going to
65. 4:14give you credit, n the aggregate, the lower the cost is for the lender and
66. 4:17hopefully that gets passed along to the consumers in a more efficient system.
67. 4:21Without this system, lenders are going to do what lenders do, which is they're
68. 4:25going to mitigate their risk.
69. 4:27What that means in practical terms is higher interest rates because that's how
70. 4:32lenders mitigate risk - they charge everybody more to subsidize the risk
71. 4:36that's posed by everyone.
72. 4:38Or more declinations - it's easier to say no to an applicant than to book an
73. 4:43applicant who you know is going to default on a loan.
74. 4:46Representing a person's creditworthiness using numbers also allegedly helped
75. 4:51prevent lending discrimination.
76. 4:53Lenders often relied on more subjective methods of evaluation prior to the
77. 4:57invention of credit scores.
78. 4:59Credit scoring when it was first developed was an advancement.
79. 5:03It is better than having some banker sit across from you and judge you and
80. 5:09read the information in your credit score because they bring a lot of their
81. 5:12subjective analysis and their own life experience into the analysis.
82. 5:16And if their life is different than your life, frankly, if it's some white
83. 5:20guy sitting across from some woman of color, that analysis can be flawed.
84. 5:25If the information is not on a credit report, it is systemically impossible
85. 5:29for your credit score to be influenced by it.
86. 5:31What is not on your credit report?
87. 5:33Things like your gender, your sexual orientation, your politics, your level
88. 5:39of education, how much money you make, the socioeconomic makeup of
89. 5:45your neighborhood, your level of education.
90. 5:48So we're able to assess credit risk looking only at the past
91. 5:54behavior that is on the credit report and only to the extent that it predicts
92. 5:59future credit risk.
93. 6:03Yet, despite its good intentions, experts say that the credit scoring
94. 6:07system still suffers from discrimination.
95. 6:10A survey of 5,000 US adults found that more than half of black Americans
96. 6:14reported having a low or no credit score, compared to 41% for Hispanics,
97. 6:1937% for whites, and 18% for Asian Americans.
98. 6:23Credit scores are based on past performance.
99. 6:26So you're going backward in history to make a judgment about the future.
100. 6:30The further we go backward in history, the deeper the structural racism in the
101. 6:34United States was.
102. 6:36Intentional Racism that happened decades ago gets baked into the cake, into
103. 6:42the system, into the institutions and policies of our society.
104. 6:47And that kind of structural racism requires no animus and no intent, but it
105. 6:53still hurts black and brown consumers.
106. 6:55If your parent put your name on a bill because they had bad credit and then
107. 6:59they were delinquent, you can turn 18 and inherit derogatory information on
108. 7:03your credit report through nothing that you did.
109. 7:06If you're a new immigrant in this country, your prior credit history
110. 7:09doesn't travel with you.
111. 7:10These credit bureaus are mostly domestic, so you show up with nothing.
112. 7:14And by the way, a blank slate is a bad place to be in credit scoring.
113. 7:19It means that you're un-scored and your information starts off low and poor.
114. 7:2419% of American adults have no credit history or are considered unscorable by
115. 7:30existing systems.
116. 7:31Sadly, what the scores do is they sort of amplify those inequalities because
117. 7:36they go in and they say, 'Okay, you're already disadvantaged.
118. 7:40Now you can be doubly disadvantaged' because the score then sort of
119. 7:44objectifies that you are somehow not worthy of being given a
120. 7:50chance, that you are somehow deserving of much higher fines and
121. 7:55fees than everyone else.
122. 7:57Errors in credit reports can also often lead to miscalculated scores.
123. 8:02A survey in 2021 found that more than a third of those polled found errors in
124. 8:06their credit reports.
125. 8:08Of more than 700,000 credit or consumer reporting complaints received in 2021,
126. 8:13more than half pertain to incorrect information on their report.
127. 8:16For me, it was a different person named Aaron Klein who didn't pay their cell
128. 8:19phone bill in New Jersey.
129. 8:21I also happen to live in New Jersey for graduate school, and this stuck with me
130. 8:24for a year.
131. 8:26One in 20 have an error so serious it could cost them either the ability to
132. 8:30get credit or a job or an apartment.
133. 8:34However, those within the industry argue otherwise.
134. 8:37When we look at our data, it is astronomically reliable.
135. 8:42So we're constantly auditing and evaluating our data.
136. 8:45Our regulators are examining us on a regular ongoing basis.
137. 8:50So they're looking at all of our systems around data integrity, data
138. 8:54reliability, how we engage with consumers, etc,.
139. 8:57Under the Fair Credit Reporting Act, credit bureaus are responsible for
140. 9:00correcting any inaccurate information on their reports.
141. 9:04But research has suggested that many consumers find errors difficult to get
142. 9:08fixed.
143. 9:09Credit bureaus are like a judge that always rules for the defendant.
144. 9:13So if your mortgage servicer says you're late, even though you really were
145. 9:18never late and you have documentation that you were never late, it will still
146. 9:22show up as late.
147. 9:24Fixing mistakes is expensive and time-consuming for the credit reporting
148. 9:28and credit scoring industry.
149. 9:30They are not incentivized to have accuracy, particularly if the mistakes
150. 9:35are symmetric and even out.
151. 9:37Our entire role in the consumer credit ecosystem is to provide reliable,
152. 9:42accurate information.
153. 9:44If we were unable to do that, nobody would have any interest in engaging with
154. 9:50us whatsoever.
155. 9:51Our position is that the system only works and we can only succeed if our
156. 9:57data is incredibly reliable and accurate.
157. 9:59And that means engaging with consumers continually to try to make sure that
158. 10:03they're able to effectively managing their credit and that they're able to
159. 10:07effectively feel as though they can interface with us about any concerns
160. 10:11that they have.
161. 10:12Another main concern is the lack of regulation and oversight that can ensure
162. 10:16fairness and transparency within the industry.
163. 10:19You know, I think the idea that the industry is unregulated is a fiction.
164. 10:23And we operate in one of the most highly regulated spaces possible.
165. 10:27You have a 50-year-old federal statute called the Fair Credit Reporting
166. 10:33Act, which essentially mandates everything having to do with credit
167. 10:37reports from our rights to challenge information, our rights to freeze our
168. 10:41credit reports, our rights to get copies of our credit reports.
169. 10:45You have the Consumer Financial Protection Bureau, which regulates
170. 10:48credit bureaus vis a vis credit report accuracy.
171. 10:51You have the Federal Trade Commission that shares that regulatory
172. 10:54responsibility.
173. 10:56I must say that the Consumer Financial Protection Bureau, which took over
174. 11:00oversight of this industry about ten years ago, they've done a really good
175. 11:04job of trying to reform the credit bureaus.
176. 11:07But I would go further than more regulation or even more laws.
177. 11:12Over the years, credit reporting and scoring agencies have made several
178. 11:16changes in response to the criticisms against the industry.
179. 11:19Perhaps the biggest change comes from the use of alternative data to improve
180. 11:23accuracy and inclusion.
181. 11:25They've started trying to incorporate other, quote-unquote, nontraditional
182. 11:28information. For example, if you pay your mortgage on time every month, your
183. 11:32credit score is going to increase.
184. 11:34But if you pay your rent on time every month, nothing happens because that
185. 11:38information isn't reported.
186. 11:39We've innovated with scores like the FICO score XD and the ultra FICO score.
187. 11:45They augment traditional credit data with rich alternative data, such as how
188. 11:50you pay your telco, utilities, as well as information that's in your checking
189. 11:55and savings account.
190. 11:56The point of these new scores is to allow consumers to find other ways
191. 12:02besides the historical credit to demonstrate their ability to repay
192. 12:06credit.
193. 12:07More regulatory changes could also be coming.
194. 12:10Two bills, the Protecting Your Credit Score Act and the Comprehensive Credit
195. 12:14Act, were both passed by the House in 2020, aimed at overhauling the credit
196. 12:18scoring system with more oversight and provisions aimed at protecting consumer
197. 12:22credit. They have yet to be put on a vote by the Senate.
198. 12:26One of the initiatives that we're championing because we really think the
199. 12:29solution to a lot of these concerns around how do you help consumers access
200. 12:33financial products is an alternative data piece of legislation called the
201. 12:37Credit Access and Inclusion Act, which would really encourage the reporting of
202. 12:42rental data, utility data, bring new data into the system that would allow
203. 12:46literally millions of Americans to access financial products and services.
204. 12:50But ultimately, credit in its current state is dependent on the consumer's
205. 12:55financial decisions.
206. 12:56I'll tell you the two things that you need to do, and it will be impossible
207. 13:00for you not to have a good score.
208. 13:02Number one, never, ever miss a payment on anything, ever.
209. 13:07That's easy. It's writing a check at the end of the month and paying your
210. 13:10minimum payment, right?
211. 13:12Number two, you've got to stay out of credit card debt.
212. 13:14And I'm not saying don't use credit cards, I'm saying don't max out your
213. 13:17credit cards. Don't use th as a supplement to your income or to keep up
214. 13:21with the Joneses or to impress somebody.
215. 13:24Pay your bills on time, stay out of excessive credit card debt, lather,
216. 13:27rinse, repeat, and you're going to have fantastic credit scores.
217. 13:30You know, 'how you manage your credit is a sign of responsibility.' It's not.
218. 13:36A lot of people have negative items on their credit report because they were
219. 13:40the victim of bad luck, not because they're bad people.
220. 13:44So they got sick, they lost their job and now they can't pay their bills and
221. 13:50their credit report is going to stop them from getting a new one.
222. 13:53That's crazy.