RateWatch #407 – Credit Reports, Scores and Disputes

May 15, 2004 by Dick Lepre

What's Happening

CPI was +0.3%. What is news is that this is news.  If folks are worried about the fact that we are running inflation at 3.3% annual then indeed inflation is contained and the fact that there is worry about inflation at this rate is likely to serve to contain it. U of Michigan Consumer Sentiment (predisposition to spend) was healthy but lower than expectation.  Industrial Production was +0.8%, Capacity Utilization was up slightly to 76.9%.  The economy is showing signs of healthy growth with little inflation.  Wall Streeters are calling for rate hikes sooner rather than later.  Greenspan may see subdued inflation as license to keep rates low for another few months to stimulate GDP. Recall that 1st Q GDP will likely be revised downward because of the high trade deficit. PPI was +0.7 overall BUT the important number is core-PPI (excluding food and energy) and that is +0.2% - which is small.  Inflation remains controlled and we continue to see increases in wholesale prices not being passed along to retail customers.

Credit Scoring and Credit Reports - a New Look

I have written about this extensively in the past but would like to take a new look at credit scoring, credit reports, disputes and what you can do to help yourself.

There are three credit repositories: Experian, Transunion, and Equifax.  Creditors report payment histories to them, they store this and produce data for credit reports and credit scores that are an assessment of risk.

Credit Scores

The credit scoring system called FICO was instituted by a San Rafael, CA. company - Fair Isaac.  The original purpose was to provide credit ratings to new car dealers. Automobile purchases are sometimes impulse buys and while the buyer/driver was salivating over that new 'Vette the salesman and dealer wanted to know if he could get financing and at what rate.

Some time around 10 years ago the mortgage industry started using FICO scoring as an objective measure of credit risk. Before that, it was left to the underwriter to count the number of lates on the credit report, rate the risk and ask for "letters of explanation" for all credit lates.  Loan officers
generally considered these to be exercise in "creative writing." Underwriters were looking for folks to construct inane explanations as to why a 30-day late on a credit card three years ago was not
really their fault.  These generally sounded like "the dog ate my homework" excuses.

The credit scoring system makes it much easier to determine what is necessary to get a loan funded.  Letters of explanation are required only for things such as collections.

Factors Used in Credit Scoring

According to Fair Isaac there are five factors that comprise a credit score:

- payment history is 35% of the pie.  This is hurt by adverse public records (bankruptcy, judgments, suits, and liens), actual payment history information, severity of delinquency (60-day lates can be deal-killers), amounts past due, time since adverse information appeared (the older the better), number of past due accounts, number of "paid as agreed" accounts.

- amounts owed is 30%.  Put simply: if you use more than 30% of a credit line your score will be negatively affected.  If you use more than 50% of a credit line the effect will be of concern. The concept here is that some folks have perfect payment histories but are "tapped out."  The scariest credit reports that I see and those where the borrower(s) have 5 credit lines, all for $10,000 and all with balances above $9,000.  Relevant to this and the "length of credit history" below is a common "knucklehead" mistake that borrowers make.  Suppose that you have 5 credit cards with $2,000 credit limits and $1,000 usage.  You get a call from the First Bank of Utopia offering you a $5,000 credit limit Visa at 2.9% for 6 months if you move the five balances to their cards.   2.9% - good deal - right? So you say yes, move the balances and close those other five accounts.  Guess what? You have bleeped up your credit. Closing long-standing accounts in favor of new accounts has an adverse effect.  The average length of time that your accounts have been opened is diminished.  Moreover, you are now using nearly 100% of this new credit line. 

If you want to get a better rate credit card, minimize the damage by doing the following:  get a credit line so that you are using 30%-50% of the line and DO NOT close the old accounts.  Pay them down to zero but do not close them.

Also note that merely having credit does not make a good score.  Using that credit and paying on time does.

- length of credit history is 15%.  If you have been a credit user for only 2 years your payment history does not speak so loudly as someone who has been paying on time for 20 years. If you are just getting out of college and see this as discriminatory then form a protest group.

- new credit counts for 10%. A large number of recently opened accounts or a large percentage of opened accounts that are new will adversely affect your score.  A large number of recent
inquiries will negatively impact your score.  Of note to folks "shopping" for mortgages by making multiple inquiries is the following:  all mortgage inquiries made within the past 30-days count as one inquiry.  If two lenders pull your credit report on the same day your score will be no more affected than if just one does so.

- types of credit - 10%.  This one is a bit strange but there is a sort of "class distinction" about credit.  Having a lot of retail store credit as opposed to Visa card credit can negatively affect your credit.  The reasoning is that department store credit comes at higher rates that credit card debt and is more readily extended.  When they ask you if you want to save 10% on your purchase today by opening a new account just say "no". 

When you get a credit score the system will give the four reasons which contributed most to imperfection. Fair Isaac lists the following as the "reasons".

- Amount owed on accounts is too high
- Delinquency on accounts
- Too few bank revolving accounts
- Too many bank or national revolving accounts
- Too many accounts with balances
- Consumer finance accounts
- Account payment history is too new to rate
- Too many inquiries in last 12 months
- Too many accounts opened in last 12 months
- Proportion of balances to credit limits is too high
- Amount owed on revolving accounts is too high
- Length of revolving credit history is too short
- Time since delinquent is too recent or unknown
- Length of credit history is too short
- Lack of recent bank revolving account information
- No recent non-mortgage balance information
- Number of accounts with delinquency
- Too few accounts currently paid as agreed
- Time since derogatory public record or collection
- Amount past due on accounts
- Serious delinquency, derogatory public record or collection
- Too many bank or national revolving accounts with balances
- No recent revolving balances
- Proportion of loan balances to loan amounts is too high
- Lack of recent installment loan information
- Date of last inquiry too recent
- Time since last account opening is too short
- Number of revolving accounts
- Number of bank revolving or revolving accounts
- Number of established accounts
- No recent bankcard balances
- Too few accounts with recent payment information.

Credit Disputes

If your credit report contains inaccurate information you can have it corrected.  To understand how to do this first get this concept clear - there are three parties: you, the creditor, and the three repositories.  If the problem item is in all three repositories you need to take care of it in all three places.  Once you are aware of the item and if your dispute is valid you need to go to the party that reported it and get a letter from them indicating that is should be removed from your credit history.

Here is where it can get confusing.  What you should do next is get your credit report from each repository. You can do this by phone or Internet.

This is the contact information for the three repositories:

Experian, Inc.
PO Box 2002
Allen, TX 75013

PO Box 1000
Chester, PA 19022

PO Box 740241
Atlanta, GA 30374

If you call those numbers you can order a copy of your credit report with a reference number that you will then use to expedite the dispute process.  You should receive the report within 4-5 days of ordering it and you will be given instructions as to what to do to dispute the items.  I have done this and it actually works.  You need to send them the letter from the creditor indicating that the item should not be on your credit report.  Do not send the repositories one of those "the dog ate my homework" letters.  They are not there to resolve the dispute, they are there to remove the data once you have resolved it with the creditor.

Medical Collections

One of the things that I personally hate about what I see on credit reports is medical collections. These usually arise from co-payment situations where you might not know until 6 months after a service is provided that you owe part of the fee and how much you owe.  At that point you might still think that your insurance is covering that payment.  Many of these get ignored and are reported to collection agencies.  A problem that I have in principal is that these folks are not reporting that you are paying on time when you do pay on time they are using the system to
assure payment when you want to purchase a home or refinance your mortgage.

Consumers find themselves on the downside of disputes between health care providers and insurance companies.

From my personal perspective medical collections should not even appear on credit reports or, if
they do, they should have near-zero weight.  They result, all too often, not because of unwillingness to pay but because of confusion that is outside the control of the debtor.

One more thing about medical collections: paying them off may actually decrease your credit score.  If it is an old item it may be a long time since the "date last active."  Paying the item will move the "date last active" to the present and lower your score.  Do not ask me if this makes sense.

Two suggestions:  first, get a letter from the collection bureau agreeing that the item is in dispute and that they will permanently remove it if it is paid. Second, if you are refinancing pay the collection off at closing. This will hurt your score for a while but presumably at a time when the effect will have little bearing.

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