What Does Credit History Really Say?
I was mulling over posting about the use of credit history and FICO score for what I’d consider ‘non-traditional’ uses. Now that I’ve read an excellent post Sun did on credit scores and insurance rates, it kicked me in the butt.
Increasingly in the media there’s been coverage of credit history and FICO scores being used to judge people in non-credit areas. Car insurers, potential employers, and prospective landlords are all using credit pulls to judge people and determine what to charge them.
Some of these might, on the surface, seem to make sense. But I’d argue using credit history in these ways is at best useless and at worst misleading.
What a Credit History Is and Is Not
It’s first important to understand what a credit history is and what it is not.
A credit history is:
- A list of your open and closed credit accounts
- Your payment history on these accounts
A credit history is not:
- An evaluation of your current ability to pay debts
- A judgment of whether your financial situation is tenable or not
- A statement of your personal integrity
Your FICO Score Depends On Who’s Asking
FICO is a score generated by Fair, Isaac using a proprietary formula. It must be understood, however, that this number is not fixed for a given person at a given time. Depending on who is asking, the score changes.
You see, Fair, Isaac sells information about you to lots of different companies. And it tells each of these companies different things about you. That is, the formula used to generate a FICO score varies depending on who is asking. A car dealership pulling your score will get a different view than an insurance company will.
Using Credit History For Non-Credit Purposes
The use of credit history for non-credit purposes is ostensibly because it indicates something about a person - the trustworthiness of a potential employee; how often someone will make an insurance claim; if they’d be a promptly-paying tenant.
I think it does a really poor job of these things for two reasons. First, people can have poor credit histories for a host of legitimate reasons largely outside their control. I’m thinking major illness, job loss, divorce, and errors on the part of creditors and/or the credit bureaus. Second, credit scores don’t capture the vital piece of information many companies fundamentally want - namely, ‘what is this person’s ability to repay me?’ Credit score says nothing about your current income situation.
So it’s my opinion that using credit histories for alternate purposes is really does not make sense.
credit insurance
June 18th, 2007 at 10:54 am
June 18th, 2007 at 7:47 pm
Thanks for the mention! I am glad that you find the information useful
June 19th, 2007 at 1:24 pm
If credit history does a poor job of indicating trustworthiness (in whatever form) for non-credit purposes for the reasons you cite it seems like it would also do a poor a job for credit purposes. Presumably, if major illnesses, divorce, etc. are sufficiently atypical that their occurence skews credit history to a greater degree than it “should” with respect to how many insurance claims a person is likely to make or what kind of employee the person is likely to be, it does the same thing with respect to how likely someone is to pay back a debt. Since a credit score says nothing about current income the FICO, in any particular case, could well be a poor indicator even for its primary purpose.
However, just because there may be individual circumstances in which the FICO is misleading, either in a credit or non-credit situation, that doesn’t mean that the FICO is misleading in either situation in the aggregate. Yeah, high FICOs default and low FICOs pay as agreed in particular cases but overall, based on how they’ve performed over long periods of time, those with higher FICOs are more likely to pay as agreed. (The race isn’t always to the swift, nor the battle to the strong, but that’s the way to bet.) If insurance companies see a correlation, even an imperfect one, between FICO scores and claim costs, it seems reasonable for them to take that into account in pricing.
I don’t see it as a lot different from charging young males more for car insurance than young females. Just because *some* males drive more safely than *some* females doesn’t mean that, overall, the insurance companies are making a poor, ill-informed, or irrational decision in charging young males more. Gender and age are not perfect indicators wih respect to driving safety, but they are useful indicators.
June 21st, 2007 at 3:07 pm
While I agree with the basic premise of this article, I don’t think it’s true that “the formula used to generate a FICO score varies depending on who is asking”.
Do you have a source for this information?
June 22nd, 2007 at 10:00 am
Paul, I’ve read this several places. Here’s one that quotes a Fair Isaac spokesman:
From CNNMoney (http://money.cnn.com/magazines/moneymag/moneymag_archive/
2003/11/01/352279/index.htm)
Moreover, the credit agencies customize the recipes for just about every industry out there. “It’s a zoo full of scores out there,” says Fair Isaac spokesman Craig Watts.
August 12th, 2007 at 10:20 am
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