The Dark Side of Credit Reports and Scores

Addressing problems with the current credit reporting system and ways in which consumers misunderstand it, privacy expert and author of "Credit Scores & Credit Reports: How the System Really Works, What You Can Do" Evan Hendricks explores the deep end of the credit-scoring pool.

At a glance

Name: Evan Hendricks
Hometown: Portland, Ore.
Education: Columbia University, B.A.
Career highlights:

• Editor and publisher, Privacy Times
• Author of "Credit Scores & Credit Reports: How the System Really Works, What You Can Do"
• Qualified by the federal courts as an expert witness in Fair Credit Reporting Act and identity theft cases
• Privacy expert consultant, United States Social Security Administration

Credit scores & credit reports
1. Why check your score?
2. Are you getting a FICO score?
3. Pre-approved offers & scores
4. The problem of mixed files
5. When to call an attorney
6. Student loans & credit reports
7. Are credit scores colorblind?
8. Credit scores & insurance rates
9. Consumer protections

While busting several misunderstandings consumers might have about credit scores, he also offers his insight and advice about advanced credit scoring topics, such as mixed consumer credit files, when to seek the help of an attorney and how the credit card industry uses credit scores to make customers pay more.

Why check your score?

Q. You say in your book, "Credit Scores and Credit Reports," that since there are five industry versions of the classic FICO score, consumers cannot rely on a score they bought online, even if it really is a FICO score. Why then should consumers bother to check their FICO scores before applying for a major loan?

A. You should check because you can still get a general idea of where your score stands by going online and getting your own score. Getting a general idea sometimes is important because if you're really high on the score line, then you'll be in good shape and if you're in the middle you know where you stand and then you know you can take certain actions if you were way down on the score line. It's still worth it to start with a general idea of what it is.

And certainly a point to understand is that when the rubber hits the road and you apply and the creditor pulls your credit report -- there could be some difference between the score you receive from what the creditor gets.

Are you really getting a FICO score?

Q. Consumers have three FICO scores based on the credit reports from the big three credit bureaus, but two of the big three credit reporting agencies sell credit scores directly to consumers that are not FICO scores at all. Do you think people realize what they're getting when they purchase these scores?

A. Unfortunately, no, I don't. I've just seen many examples where a consumer's trying to be an educated consumer and get an idea of what their score is and what's offered to them from Experian and TransUnion are the knockoff scores, or FAKO scores. Those will differ even more greatly than what the creditor will judge them on, in most cases. Partly because the other scores such as the TransUnion TrueCredit score operate on a different scoring scale. I think TrueCredit goes to either 900 or 950 -- whereas the FICO stops at 850. So the TransUnion score will give the impression oftentimes that your score is better than it is.

To my knowledge, lenders don't use any of these scores that are sold directly to consumers by Experian or TransUnion. That's why they're called educational scores. But sometimes the education is very bad.

Pre-approved offers & scores

Q. Some people might think there's no need to check their score because the pre-approved credit card offers they're getting in the mail offer great rates. Would you discuss why the rates and other come-ons mentioned in "preapproved" offers may not mean that the consumer has a high credit score?

A. The name of the game in credit cards is to acquire as many customers as you can and then drive them up to as high an interest rate as you think that they will pay. It's called "rate maximization." The name of the game is rate maximization, because the higher the interest rate that card customers pay, the more the credit card company makes. And so, there's a lot of ingenuity used in marketing to customers that might be in precarious credit situations with large credit card balances. That's where the whole balance-transfer approach came from. There's a certain part of the market or the industry that likes catering to people with middle, lower and really-low scores because they see there might be greater profit margins there. That's what drove the whole subprime credit business for the last several years, which now has the chickens coming home to roost.

But the basis of the philosophy is: These are consumers that either have trouble saying no to credit, or when they get credit, they have trouble managing it responsibly, but if we give credit to them and they pay the way they're supposed to at our rates, we're going to do very nicely. In some sense, it's kind of like a suckers list. There are car dealers and others that will get lists of consumers who just went through bankruptcy, and they start marketing to them. It comes it all shapes and sizes.

So, you can't be sure you have a good credit score based on the preapproved credit card offers you receive.

Q. Do you think people realize they are not really preapproved?

A. I don't think people appreciate the fact that preapproved does not mean preapproved. When they send you that so-called preapproved offer, they always have a right to run one last check. And worse, there's what they call a "counter-offer loophole." In that preapproved offer, if you respond and say "yeah, I want this card at this attractive rate," they can send you a card that has a higher interest rate and only tell you about it in the fine print. Then, if you accept that card and activate it, you've accepted the counter offer. Most normal people really wouldn't be expecting to find in the fine print that oh no, I didn't get the 6.9 percent they offered me, I got a 13.9. It's a very tricky business.

I just think that while credit cards are this wonderful, convenient thing that allows us to go out and buy stuff -- even if we might not have the cash in pocket -- a smart consumer would have a very low trust level for credit card companies. Credit card companies basically do best the higher the interest rates they can charge and when they have several reasons to charge higher interest rates. You just can't be very trusting when it comes to credit cards.

The problem of mixed files

Q. In your book, you talk about the problem of mixed files. Could you briefly discuss what they are and how they can wreak havoc on consumer credit reports and scores?

A. A mixed file is when someone else's information comes on to your credit report. It can wreak havoc because if you have good credit and the other person whose information is coming onto your credit report has bad credit, those bad accounts -- or tradelines as they're called in the industry -- are going to lower your credit score.

And, if you try and dispute this and correct it, it doesn't always work, mainly because the system is so automated. Sometimes the dispute process works, but it's so automated that sometimes the computers look at your dispute and wrongly verify the information without doing a really good investigation. You get a letter back saying the credit agency verified this information, when in fact it verified false information. And that wreaks havoc on people because then they have to dispute again. And then finally, even if the dispute does work, it could come back on your report. There have been cases where because of the way information is routinely reported every month by the big creditors to the credit bureaus, the word doesn't really get back to the creditor who's doing the original reporting and so, they don't take the bad information out of their computer systems that do the reporting every month and so in another month or two, it can be back on and you won't know about it.

The only way you'd know about it is by getting another copy of your report and finding out that "oh gosh, it's back on again."

Q. What causes mixed files to happen?

A. Mixed files happen because of similarities first in Social Security numbers, and then in names. Addresses and geographical locations also will play a role. So, the first thing people have to understand is the use of what we call a "partial matching algorithm" to decide if you are you, or what information goes into your file that they're going to sell to a creditor. The general rule is if seven out of the nine digits match, they consider that a partial match, provided that some of the name information will match up as well. So, people who have only one or two digits different in their Social Security numbers and have enough common letters in their names and live in the same geographic region could be considered to be the same person by the computers, and that causes a mixed file.

Q. If a consumer's file is mixed with somebody else's, will the consumer be able to see that on his or her credit report?

A. Well, if consumers get their report, they will be able to see that at a minimum, there are accounts on their credit report that they know are not theirs. What often happens is that in a mixed-file case, the address of the other person will either become your current address or your previous address. And that will be your hint that you're a victim of a mixed file. The same goes for identity theft, by the way, because the credit bureaus rely on what's reported to them by creditors. And so, if Leslie A. McFadden in Savannah has information coming in from Capital One and you -- I don't know what your middle name is -- Leslie B. McFadden, you have this two digits' difference in your social, then you're going to start seeing rotisserie addresses -- basically, where whoever reported most recently becomes the current address. The address can start flip-flopping if you get your credit report every month.

When to call an attorney

Q. When should a person get an attorney?

A. I think that when you've gone though the dispute process, and you've sent in a dispute and you've attached the documentation such as your driver's license, copy of your Social Security card and any other information showing why the information is wrong, and they still don't fix it after a couple disputes, it's time. Or, if they do fix it and it's back on in a couple of months and you dispute it again. Once it goes wrong two or three times and you can't get any justice, then I strongly advise seeking an attorney that specializes in these sorts of cases. You find them at the Web site Naca.net, which stands for National Association of Consumer Advocates.

Student loans & credit reports

Q. A point made in your book is that students and graduates who have student loans should check their credit reports. Why is this necessary if the student or graduate is making payments on time?

A. They should check firstly for the same reason as anyone else, to make sure that their payments are reported correctly because inaccuracies can creep in anywhere in this huge, automated system. The second thing is that student loan information will sometimes multiply like rabbits on the credit report because student loans are sold from one company to another and the old company continues reporting and then the new company continues reporting it and it might make it look like you have more loans than you actually do. Then if they're showing any late payments, you can get hit with double whammies on late payments as well.

Q. And they can get those duplicate entries removed?

A. Yes. When you dispute, they're supposed to investigate -- or, I guess the statutory term is reinvestigate -- your dispute, and make a decision in 30 days. Either remove it or modify it or tell you that it's been verified. And so, when the dispute process works the way it's supposed to, it's a good system. It's just I can see the cases where it doesn't work the way it's supposed to.

Are credit scores colorblind?

Q. Where do you stand on the issue of whether credit scoring disadvantages minorities?

A. That gets into a wonderfully philosophical debate about where people stand in society. I would agree that in one sense that credit scoring is colorblind because it's based entirely on information in the credit report. That way I would agree with industry's defense of credit scoring. But on the other hand, different people from different cultures have different ways of looking at their finances. And, there's been a low trust of the financial system among significant segments of the African-American community, the Hispanic community, the Asian community, just to name a few. And some of the people who are most suspicious in those communities, and even Caucasians who are suspicious of the way the financial system and consumer finances work, are actually very responsible with their money. They pay their rent or their loans, they just don't like having a lot of credit cards or they don't like having a lot of loans out. But when something happens in their life and they actually need to buy a home or help a relative buy a home, then they're going to be at a disadvantage because they don't have a thick enough credit history to produce a good credit score. And so, the philosophy in my book is that yeah, there are definitely philosophical reasons to question how powerful the system has become. But there's no question it's a powerful system, and that you need to know about it so you can make the right decisions for yourself and your family.

Credit scores & insurance

Q. Should credit scoring be used, in your opinion, in insurance granting and pricing decisions?

A. I think it's problematic that credit scoring is used in many, many ways for car and homeowners insurance. The industry is passionate in saying that the research shows that customers with low credit scores cause insurance companies more losses. But even there, I'm not sure to what extent that should justify the way that they use credit scoring for setting auto and homeowners insurance. It seems to me it should be based on standard underwriting criteria. But putting that philosophical debate aside, there's no question that it's a very important factor in setting those rates, especially for new applicants. And so, I think it's something that people don't understand intuitively but need to know because sometimes the credit score can be just as influential as your driving record when it comes to your auto insurance rate.

Consumer protection

Q. What, in your opinion, should be done on the federal level to help protect consumers with regards to credit reports and scores?

A. There's very little in the way of enforcement by any of the federal agencies when it comes to credit reporting issues. The Federal Trade Commission is supposed to take enforcement actions against the credit bureaus. They've done a handful of cases about not answering the telephones, but they haven't gone to the heart of these problems.

And, the law is designed so that you, as a consumer, can only go to court after you've submitted your dispute to the credit bureaus and the credit bureaus have relayed it to the creditor and then the creditor failed to do a reasonable investigation. Then you go to court.

In the meantime, the whole thing about initial reporting from creditors to the credit bureaus means the creditors are supposed to report accurate information. But individuals can't go to court to enforce those rights, that's left to the banking agencies -- the OCC, the Federal Reserve and the others, maybe the FDIC -- those agencies have not taken any enforcement actions in 10 years. That's a glaring hole. When I told you that these companies don't care because they don't feel they have to, one reason is because those federal agencies are not doing their job and taking enforcement actions to make them care.

Congress has, since the law was enacted in 1970, done a major strengthening of the law for consumers in 1996 and they did another strengthening of the law in 2003, but the credit bureaus and many creditors on these issues are like naughty children. If you don't keep the boot on their neck, they're just going to continue to have procedures in place that disadvantage consumers. In other words, you give them wiggle room, they exploit it to disadvantage consumers. So they're going to need to have even more specific standards in place so consumers can get their errors corrected without having to go to court. The law basically will need to be strengthened again.