While Matt certainly isn’t alone in his opinion about credit scores, his irritation seems to be based in part on either bad advice or simple misunderstandings about how credit scoring works.
1) The biggest problem is the score on which he’s focused. If he’s getting his score from an Experian credit monitoring services then he is getting his ‘PLUS’ score. PLUS is a scoring system developed by Experian for use on their consumer Web sites. PLUS is not available for use by lenders. It is an educational score, that’s it. So, he can improve that score all he wants and it won’t do him a bit of good. In fact, Experian is being sued, class action, because of that very score and how it’s tacitly marketed as being a relevant score in the lending environment.
(Here’s how Experian’s own Web site describes the PLUS score: “The PLUS Score, with scores ranging from 330 to 830, is a user-friendly credit score model developed by Experian to help you see and understand how lenders view your credit worthiness. It is not used by lenders, but it is indicative of your overall credit risk. Higher scores represent a greater likelihood that you’ll pay back your debts so you are viewed as being a lower credit risk to lenders. A lower score indicates to lenders that you may be a higher credit risk.”)
2) He set himself up for scoring problems when he closed his credit cards in 2006. Don’t get me wrong. What he did was completely understandable, as common sense dictates that having credit cards could be problematic. The problem is that credit scoring systems reward consumers for having unused and available credit limits. He eliminated that when he closed his cards.
3) When he opened a new card before he took a recent trip (per his blog) he was assigned a credit limit of $5,000, which is a modest limit. When he made charges on that card his debt-to-limit ratio (also called Revolving Utilization) shot up because even modest vacation charges on a $5,000 card are going to result in fairly leveraged card. This is compounded by the fact that he had closed his pre-existing cards in 2006 (#2 above) thus leaving himself no unused available credit on other cards, which would have helped to balance out any spike in usage of the one new card.
An easy way to understand this is…
$5,000 card with a $2,500 balance = 50 percent utilization (not good). However, if he would have paid off the old card (the one with the $20,000 limit) and left it open then the math shakes out like this…
$25,000 in aggregate limits and $2,500 in aggregate balances = 10 percent utilization (very good).
4) Here are some incorrect understandings he has about credit scores, which contributed to his irritation.
Mr. Haughey: I used to think a credit score was all about your ability to pay, but it’s clear now it’s more about how profitable you will be to banks.
A credit score is not a tool used by lenders to predict your ability to pay, and they have never been billed or represented as such. Your ability to pay (or “capacity”) is measured by your income and holdings.
Credit scores predict whether or not you are likely to pay your bills, a big difference. Credit scores are completely dependent on information on your credit reports, hence the term “credit score.”
Income, assets, holdings, net worth and all other wealth metrics are absent from credit reports. Credit scores CAN’T consider these things because they’re not on your credit reports. Credit scores reward you for properly managing your credit, not for making a lot of money. I’m thankful for this because if it was all about wealth then lawyers, doctors, executives and professional athletes would have the highest scores and hourly employees would have the lowest scores.
Mr. Haughey: “I had the highest credit score at a time in my life when I was leveraged to the hilt and I lived paycheck to paycheck.”
As insane as this is going to sound, that makes perfect sense. Credit scores are designed to measure how well you manage your credit so if your credit reports reflect sound credit management your scores are going to be very good.
Mr. Haughey: “Financially, I’m in the best shape of my life right now. My house will be paid off in about five years at the rate I am going, I have a great retirement portfolio that I contribute aggressively towards and it continues to grow, and my business is doing well even as we’ve expanded with a new employee and several contractors.”
This is great but nothing stated above has anything to do with credit risk. As such, it doesn’t have a direct influence on your credit scores.
My advice for Matt is to:
A) Ignore about 80 percent of the comments on his blog because they’re either incorrect or inflammatory.
B) Get his real FICO scores from FICO’s Web site, myFICO.com. I’ll even pick up the tab for his scores just to do my part in pointing him in the right direction.
C) Study up on what will improve your FICO scores, not what will improve your PLUS score. There’s plenty of really good educational materials available for download at the FICO Web site.
Article source: http://feeds.nytimes.com/click.phdo?i=15940754601fe92bb4caa7a141365dc5
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