Credit Reports and Scores: Practices, Policies and Outcomes Chi Chi - PDF document

11/16/2012 Credit Reports and Scores: Practices, Policies and Outcomes Chi Chi Wu cwu@nclc.org Financial Education in Oklahoma November 7, 2012 National Consumer Law Center  Legal resource center on consumer law issues focusing on low-income consumers  Resource materials, policy and advocacy  Impact litigation 1

11/16/2012 Importance of Credit Scoring and Reporting in the U.S. Financial “ report card ” for most Americans • • Gateway to credit and other essentials – Home (mortgage) – Car (affordable auto loan) – Education, small business – Increasing Non-Credit Use • Insurance • Employers • Landlords • Serves beneficial purposes BUT Credit sometimes also serves to mask stagnant wages and gap with rising costs “ No advertisements trumpet, ‘ When your husband leaves you, there ’ s MasterCard. ’ Nor do we hear: ‘ American Express: Don ’ t lose your job without it. ” But those slogans would be closer to the truth about how credit is used today ” From “ The Cement Life Raft ” in Elizabeth Warren and Amelia Warren Tyagi, The Two-Income Trap . 2

11/16/2012 “ But over the past 30 years, as income growth slowed and the cost of critical necessities like health care climbed, Americans took on debt just to make ends meet. Today, a quarter of adults who are working full- time are not earning enough money to meet their family ’ s basic economic needs…. families without assets to fall back on borrowed against the value of their homes and relied on credit cards as a privatized “ plastic safety net ” to get through hard times ” Demos, The Plastic Safety Net, May 2012 The Players in Credit Reporting • Consumer reporting agencies (CRAs) or Credit Bureaus – 3 major CRAs or “ credit bureaus ” (Equifax, Experian, Trans Union) • Furnishers of information • Subscribers or users of information 3

11/16/2012 Types of Information in a Credit Report • Basic info (Header) – Name – Current and former addresses – Birth date – SSN – Can include telephone numbers; spouse; Past and present Employers. Types of Information in a Credit Report (cont.) • Payment History on Credit Accounts – Mortgages; auto loans – Revolving accounts (credit cards) – Collection agency entries • Inquiries • Public record information – Bankruptcies – Foreclosures, tax liens – Court judgment and filings 4

11/16/2012 Sample Report 7 Winthrop Sq., 4th Fl. Boston, MA 02110 Phone: (617) 542-8010 Fax: (617) 542-8028 How We Grant Credit • Based on Credit Scores and Credit Reports • Advice for a High Credit Score From Experian.com – “ Pay your bills on time. Delinquent payments and collections can have a major negative impact on a credit score. ” – “ Keep balances low on credit cards and other "revolving credit." – “ Apply for and open new credit accounts only as needed. “ – “ Pay off debt rather than moving it around. ” Based on the “ Rational Borrower ” • – Like the “ Rational Man ” of classical economics 5

11/16/2012 The Assumption Behind Credit Scores and Reports The Reality 6

11/16/2012 Reasons for a Bad Credit Score • Irresponsible Borrower? OR • Medical Debt – 50% of all debt collection accounts on credit reports are for medical bills • Illness • Job Loss • Divorce • Victim of Predatory Lending or Other Consumer Abuse • ID Theft; wrong consumer Myths and Realities • The myth about consumers behind on their bills: “ They are all deadbeats ” • 1974 Study: Can pay but won ’ t is about .1% (one in a thousand) 7

11/16/2012 Unemployment Rate, U.S.A. January, 1995-2010 12.0 10.0 8.0 t) n e rc 6.0 e (P 4.0 2.0 0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bureau of Labor Statistics http://www.bls.gov/data/ Bank Credit Card Chargeoffs 12 10 8 t n e rc 6 e P 4 2 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 Source: FRB Statistical Releases http://www.federalreserve.gov/datadownload/ 8

11/16/2012 From 30,000 feet to the Nitty Gritty • Errors – What is the level of errors? – Even 1% means 2 million consumers • Problematic procedures – Matching data by use 7 of 9 digits of SSN – causes mixed files – Metro 1 versus Metro 2 – Re-aging, duplicate tradelines, • A travesty of a dispute system Back up to 30,000 feet • Oligopology of Three • Completely Private Corporations – Publicly traded – Keep this critical file full of sensitive personal information – Essentially a public utility • Normal Market Forces Do Not Work Here – Customers of Big Three are mainly the subscribers – Consumers cannot “ walk with their feet ” “ American style ” credit reporting is a given • – In some countries, government or central bank function – Privacy laws prohibit private companies from doing this 9

11/16/2012 Does the Current Scoring System Make Sense? • 35% is payment history BUT • 30% is ratio of credit used to credit available 10% is “ mix ” of credit • – so need a home and mortgage • To even get a score – The “ haves ” - student loans, authorized users, college credit cards – The “ have nots ” – the “ on-ramps ” can be fraught with danger • Subprime cards, store cards, secured cards • Alternative data can be risky Policy Implications of Credit Reporting • Makes credit more available • Historical unlevel playing field – Scores correlate with race, income, home ownership. – Gaps might be widening over time – “ path dependent ” • Does scoring make inequality worse? 10

11/16/2012 Regulatory Scheme – Fair Credit Reporting Act • Procedural Protections – Right to free annual credit report and to buy credit score (15 U.S.C. 1681g) – Notices when used for adverse action or risk-based pricing (15 U.S.C. 1681m) • Privacy Protections – Restrictions on who can view report (15 U.S.C. 1681b) • Creditors, insurers, employers, debt collectors, landlords • “ Legitimate business need ” Regulatory Scheme – Fair Credit Reporting Act • Accuracy and Obsolescence Protections – “ Reasonable procedures to assure maximum possible accuracy ” (15 U.S.C. 1681e(b)) – Furnisher accuracy standards (15 U.S.C. 1681-2(a)) – Prohibition against negative information over 7 years (10 years for bankruptcy) and certain medical information (15 U.S.C. 1681c(a)) – Dispute rights (15 U.S.C. 1681i and 1681s-2(b)) • ID Theft Protections – Alerts, blocking – Red Flag guidelines, disposal 11

11/16/2012 Gaps and Holes • FCRA does NOT require – Any specific procedures that the bureaus must follow – What kind of information must be provided – What kind of information (besides old info and certain medical info) cannot be provided • Could credit reports include astrological signs? – Social benefit • Other Gaps and Problems – Many provisions are not privately enforceable – Preempts better state laws and common law claims • Mechanics versus utility The CFPB and Credit Reporting • New Regulatory Regime for the FCRA • Rulemaking – CFPB has broad rulemaking authority • Supervision – CFPB supervises - Larger participants in a market for consumer financial products or services, i.e., the Big Three and others - Big banks, mortgage industry, payday lenders, private student lenders (furnishers) • Enforcement 12

11/16/2012 Racial Disparities Study after study finds certain minority communities have lower scores as a group • 2012 CFPB Report – Median FICO score for majority minority areas was 34 - vs. 52 for low minority areas • 2009 Woodstock Institute report • 2007 Federal Reserve Board report to Congress. – Mean score of African Americans was half that of whites (54.0 out of 100 for whites versus 25.6 for African Americans) with Hispanics mean of 38.2. • 2007 Federal Trade Commission study – African Americans and Hispanics strongly over-represented in the lowest scoring categories. Racial Disparities ( cont.) • 2006 Brookings study • 2004 Study by Federal Reserve researchers • 2004 Harvard Joint Center for Housing Studies study • 2004 Texas Department of Insurance study • 1997 Fair Isaac analysis • 1996 Freddie Mac study – African-Americans were three times as likely to have FICO scores below 620 as whites. – Hispanics are twice as likely as whites to have FICO scores under 620. 13

11/16/2012 The $67 Billion Question WHY? • Historical unlevel playing field – Scores correlate with income, home ownership, better loan terms. – Gap widened over time • Fewer resources and more demands • Lower credit limits by zip code Non-Credit Uses of Credit Reports • Insurance • Employment screening • Other: tenant screening, hospitals 14