The Three-Digit Number that Can Wreck Your Life
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The Fiscal Times
July 14, 2011

It sounds like a perfect solution for businesses — a single data point that lets companies know who is trustworthy and who isn’t. That’s the idea behind credit scores, which were developed in 1958 by FICO Inc. as a way for lenders to determine the likelihood that a customer would repay. Since then, however, the use of the scores has spread well-beyond the financial services industry. And for people emerging from the recession with a low number, that could mean higher interest rates, rejection by a landlord, and an even tougher time finding a job.  Now lawmakers and consumers’ advocates are challenging the widespread use of the numbers.

Thanks to the Great Recession, the number of people with bad credit is larger than ever. The three major credit bureaus (Experian, TransUnion, and Equifax) come up with scores ranging from 300 to 850 by using FICO’s mathematical algorithm to analyze consumers’ credit histories. Currently, more than 25 percent of consumers—43.4 million people — have credit scores below 600,  according to the latest data released by FICO, a serious red flag.

Historically, only about 15 percent have such low ratings. Those with sub-600 scores are likely to be rejected by mainstream lenders and insurers, and if they do manage to get approval, they pay much higher interest rates and premiums. Even for consumers with scores in the low-600s, the consequences can be enormous. A borrower in Iowa with a score of 630, for example, would end up paying $52,535 in interest more than a borrower with a credit score of 770 on a $150,000 balance over the course of a 30-year mortgage.

But there also are less obvious consequences, as Alexis Moore, 36, learned the hard way. In 2004, she fled the Sacramento, Calif., apartment that she shared with an abusive boyfriend. That gave him access to her credit cards and other personal information, which he used to steal her identity and go on a $50,000 shopping spree. Within weeks, scores of collection agencies were calling her, and her credit score had plunged from 750 to 587.

Now Moore, who has experience in banking and collections, is having trouble getting a job because of her weak credit. In the past several weeks, she has been turned down for jobs at three banks. In each case, she got a letter telling her that she was rejected because of her credit history, even though she says her credit file includes a note that she was a victim of identity theft.

Good People With Bad Credit

Bad credit is most often the result of missed or late payments or bills. But consumer advocates say that as in Moore’s case, it can be caused by unexpected adverse circumstances. . Divorce can leave one partner with the unpaid debts of their former spouse. Unpaid medical debts can accumulate because a person lacks health insurance. People targeted for predatory loans during the real estate boom lose homes whose payments they can no longer handle. And research suggests that more than 20 million Americans could have material errors on their credit reports.  Those mitigating circumstances, however, often don’t make it into credit checks.

Meanwhile, credit scores are more widely used than ever. As many as 60 percent of employers now run credit checks on at least some applicants—up from 42 percent in 2006 and 25 percent in 1998, according to the Society for Human Resource Management.

Insurers also are increasingly using credit scores to set premiums on auto and home policies. Industry experts say there is a correlation between low credit scores and a high number of claims. A 2007 Federal Trade Commission study on the use of scores in car insurance concluded that “credit-based insurance scores are effective predictors of risk under automobile policies.” And there’s some evidence that companies’ use of scores in setting premium rates is good for consumers, according to Alex Hageli of the Property Casualty Insurers Association of America. He points to a survey by the Arkansas Insurance Department last June that shows approximately 32 percent of policyholders paid less because of scoring, while only about eight percent ended up paying more.

STEVE YODER writes about business, real estate and other domestic policy issues. His work has appeared in print and online at Salon, The American Prospect, Men's Health, The Crime Report, and elsewhere.