Changes in the works for credit scoring system
Posted on September 4, 2007
Filed Under Credit Card News | 1 Comment
The rules that govern how consumer’s credit scores are calculated will soon undergo a few changes to help close a credit-boosting loophole.
The Fair Isaac Corp., the company that developed the commonly used and accepted FICO credit score, has announced the changes.
Of these changes, the most significant one for the majority of the population involves ‘authorized users.’
According to Andrew Conner of Mortgage Resources in the Midwest, authorized users are people who have permission to charge items to a credit card but are not responsible for making the payments on the card.
An example of this would be if someone held a credit card in their name and then put their spouse as an authorized user. The spouse would still be able to use the card, but would not be legally responsible for meeting the card’s monthly charges.
The flipside of this is that the authorized user on the account also received the benefits of the primary cardholder’s credit rating when their credit score was calculated. So, if someone with a poor credit rating became an authorized user on an account with a great rating, the authorized users score would increase significantly.
‘Automatically a bad person suddenly had great credit, even if they were an undeserving person,’ Conner said.
According to financial columnist Pat Earnhardt of National Mortgage Access Inc., the exploitation of this loophole to make money is called ‘piggy backing’ and is a major reason for the overhaul.
She states that a person with no credit score or a low score would pay a fee to rent a spot as an authorized user on a stranger’s account.
Connor said this may have contributed to some of the problems with the sub-prime market, as it allowed people with poor or zero credit to receive loans they couldn’t otherwise handle.
‘It was definately a scam,’ Connor said. ‘It falsified people’s true credit rating.’
This fall, the Fair Isaac Corporation will change the rules so that authorized users no longer receive a bump to their credit score.
While the exact formula used to calculate FICO scores is closely guarded, Connor explained some of the factors that go into it.
‘Of the overall score, 35 percent is your payment history, 30 percent is your balance-to-limit on credit cards, 10 percent is based on inquiries and the final 10 percent looks at the mix of accounts you have,’ he said.
Of these, Connor highlighted the inquiries as being most important, as people often don’t realize that requesting to see their credit score too many times can be harmful to one’s overall rating. This also includes inquiries made by banks or retailers.
While it is not a very large detraction, it can still lower your credit score, he said.
Conner said the new rules would not allow an authorized user account to qualify as a tradeline. A tradeline is any line of credit, such as a credit card or car loan.
Some loans, particularly mortgages, require the borrower to possess a certain number of tradelines in order to qualify.
Tom Quinn, Fair Isaac’s vice president of scoring solutions, said it was a challenge to find a solution addressing this credit borrowing problem because there was no way to distinguish between family members and strangers due to privacy laws and the Fair Credit Reporting Act.
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