The Carr Report: Is the credit scoring system fair?

by Damon Carr
For New Pittsburgh Courier

I get into more arguments about credit scores than any other subject I cover. People have a love affair with their credit score. Many mistakenly believe that a credit score is their financial report card. It’s not! A financial report card will take into account your income, debts, savings, investments, assets, insurances and other financial details.

As you’ll see in this article, I understand how the scoring system works. Before I go into details about credit scores, let me first say that your focus should always be on raising your net worth—not raising your credit score.

A high net worth will lead you to financial freedom and financial independence. A high credit score will lead you to more debt and more bills. A high credit score emphasizes you “managing your debt.” A high net worth emphasizes you “eliminating your debt.”

When you apply for a car loan, insurance, credit cards, personal loans or a home loan, etc., they will evaluate your FICO score, also known as a credit score.

There are many scoring models that exist. FICO, which stands for Fair Isaac and Company, named after its founders, is the most recognized scoring model of them all.

A FICO Score or any credit score is a comprehensive, mathematical evaluation of your credit profile. It looks at various factors and forms an objective view of your credit behavior. The system measures your borrowing and payment patterns against a database of borrowing and payment patterns of the general borrowing population. It then develops a score ranging from 350-850.

The higher the score, the more likely you will repay your debts on time, posing little risk to the lender/investor. The lower the score, the more likely you will default on your debts, posing great risk to the lender/investor.

These FICO scores have proven to be accurate and most, if not all, lenders rely on them.

A score of 680 and above is considered to be a good credit risk.

There are five factors that determine your FICO score. Here are the factors that determine your credit score broken down broken down by priority:

• 35 percent of your score is based on your past payment history on an existing account. Recent payment history is weighted more heavily.

• 30 percent of your score is based on the amount you owe on your debt in relation to your credit limit or original balance.

• 15 percent of your score is based on how long you’ve been using credit.

• 10 percent of your score is based on you shopping for new credit. Note: Be careful when shopping for credit. It can give a new meaning to the phrased “Shop to you Drop.” Many inquiries and/or many new credit accounts will result in lower scores.

• 10 percent of your score is based on the mix of credit you hold, including credit cards, installment loans, leases, and mortgage.

Bankruptcies, judgments, collection accounts and accounts written off as a profit or loss are an indication of not making timely payments and results in reduced scores.

There have been many debates about whether or not the credit scoring system is adverse against Black people and other minorities. Based on my experience, I would have to say the credit scoring system is fair.

Here is the basis for my reasoning. Most mortgage companies offer a free credit analysis. The credit analysis is free for the applicant but it’s not free for the mortgage company. A tri-merge credit report costs anywhere $15-$60 per person. Therefore a tri-merge credit report for a married couple cost anywhere from $30-$120.

On average, a loan officer takes about six applications per day. Some may qualify. Some won’t. Some may be interested in the loan they qualify for. Some may not.

While the average loan officer takes six applications per day, only two or three of those applications may turn into a deal. Let’s do the math. That’s 30 applications per week and only three actually turn into a deal.

While working for other mortgage companies, I pulled a credit report on every person I talked to. The company paid for the cost. Not me. When I became an owner of a mortgage and financial planning company, I had a whole different mindset. Credit reports I pulled had a direct effect on my bottom line. As a result, I had to figure out a way to offer a free credit analysis and mitigate the cost.

The solution: I studied the factors that determine the credit score. I also reviewed files that I had previously worked—evaluating their payment and borrowing habits and their credit score.

Before I considered pulling a credit report, I’d ask questions that I will be looking for on a potential customer’s credit report. I ask them questions based on factors that the scoring systems use to determine a credit score.

I worked with people of all ethnic backgrounds. I knew whether or not it was worth incurring the expense and pulling a credit report. I grew so comfortable with this process that I’d pull a person’s credit report at the last minute.

During this time when I was originating mortgage loans, I never had a mortgage application fall through following this approach.

Below are some tips to help you retain or regain good credit scores:

• Correct errors on your credit report

• Pay your bills on time

• Pay off delinquent accounts

• Don’t max out your credit cards (never allow balance to equal more than 30 percent of the limit)

• Don’t apply for credit too often (a lot of inquiries and new accounts can reduce your scores)

• Don’t have an abundance of open credit cards and installment loans (three trades is more than sufficient)

• Use credit only when absolutely necessary

For more on FICO scores visit www.myfico.com

(Money Coach Damon Carr can be reached at 412-216-1013 or visit his website at www.damonmoneycoach.com.)

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