Many people have questions about the credit scores generated by Fair, Isaac & Co. Today on Tech Ticker, Aaron Task and I figured we’d take our questions straight to the source: Mark Greene, chief executive of Fair, Isaac & Co., creator and proprietor of the FICO score.

“The FICO score is a measure of a consumer’s financial health and creditworthiness,” Greene says. It’s simply a number, ranging from 300 to 850 — the higher the better. The average FICO score in the U.S. is about 700, and pretty much every bank in the country uses a FICO score when making lending decisions. But while the scores are important, they’re not the be all and end all.

“Scores are meant to be one of several things bankers use in doing what we call sound underwriting,” Greene says. Lenders should also be taking into account borrowers’ background references, their capacity to repay loans, and collateral.

FICO creates the score simply by feeding numbers into its formula: “It’s based on pure, statistical evidence, with no judgment or evaluation or emotion.” The main factors Fair, Isaac takes into consideration are:

• How much total indebtedness a consumer has

• How long they’ve had the debt. “Newer relationships are riskier than things you’ve been paying over a long period of time,” Greene says.

• How much available credit is being used: “If you’re close to the edge on your credit cards, that’s a danger signal.”

• The mix of an applicant’s credit portfolio — is it all credit cards (bad) or a mixture of credit cards, a mortgage, and a car loan (better)?

Greene outlines three key ways through which people can improve their scores. First, pay your bills on time. Second, don’t get close to the edge: “Don’t use more credit than you really need.” And third, don’t apply for new credit unless you absolutely have to.

It may sound obvious, but the easiest way to avoid a sharp downgrade in your FICO score is to stay current on your mortgage and stay solvent. “One thing people should know is that a foreclosed home or personal bankruptcy is the most severe harm that you can do to your credit score,” Greene says. FICO scores can fall by as much as 150 points when borrowers walk away from mortgages or declare bankruptcy; it can take up to seven years to rehabilitate the rating.

Greene helps clear up what may be some misconceptions about the way credit scores are calculated. For example, is it true that every time you apply for a loan it hurts your score?

“It depends on the kind of product you’re shopping for,” says Greene. With car loans, for example, Fair, Isaac understands that people shop for rates. “If you apply for five different car loans within a couple of days, we understand that you’re looking to buy one car at the best rate. And there’s no adverse impact on your credit score.”

On the other hand, when people apply for five different credit cards in the space of a week, they’re usually seeking to open multiple accounts simultaneously. “In those situations we will take a few points off someone’s FICO score because we’re worried they’re sending a signal that they need too much credit.”

Is it also true that people who have little or no debt may find themselves with lower credit scores? That can be the case. “Warren Buffett used to say that he didn’t have a particularly high credit score,” says Greene.

Consumers can obtain their FICO score from the company at myFico.com. Greene also points to a just-launched website, scoreinfo.org, that helps people understand how credit scores factor in this new era of financial regulation. As of January 2011, you have the right to receive your score any time a lender makes certain kinds of decisions — e.g., if you’re denied credit or given credit on less than the most favorable terms a lender offers.

In the U.S. economy today, people may frequently find that a credit score is being used by companies to make decisions that have nothing to do with credit. Credit scores have become part of the application process for jobs, car insurance, and health insurance. Greene notes that the credit score can be useful in non-lending contexts: “People who are good with their finances frequently turn out to be good drivers.” But he reiterates that they were designed for a purely financial use.

Medical Debts Could Kill Your Refinancing
by Cristina Lourosa-Ricardo
Wednesday, December 22, 2010

Two erroneous $11 doctor bills stopped Jeanne White from refinancing her home.

The 49-year-old resident of Colleyville, Texas, says she was shocked to learn in October that the two medical bills, which had been turned over to a collection agency, had caused her credit score to fall to 680 from 757 — making refinancing far too expensive.

“I was told I’d have to pay $14,000 in closing costs to get a 5.5% interest rate,” Ms. White says, substantially more than she would have paid with a higher credit score. When Ms. White, a retired sales manager, contacted the doctor’s office, she found out the bills had been issued in error.

Otherwise well-qualified borrowers with good loan-to-value ratios and steady employment are increasingly finding it difficult to refinance because of medical billing mistakes marring their credit, say mortgage bankers and real-estate agents.

Some 14 million Americans have errors on their credit report because of medical collections, according to the Commonwealth Fund, a Washington-based nonprofit focused on health-care research. These routinely small-balance blemishes, which can go unnoticed for years, can be a death knell for refinancing because they can cause outright refusals — or make closing costs so high that borrowers opt not to refinance at all.

A bill winding its way through Congress could provide relief for homeowners with medical-debt troubles. The Medical Debt Relief Act, which passed the House this fall and is now in the Senate, would remove settled medical debt from credit reports after 45 days, instead of the customary seven years.

Yet borrowers shouldn’t wait for relief from Washington, says Mark Rukavina, executive director of the Access Project, a Boston-based health-advocacy group. They need to take action themselves.

“Don’t assume that your credit score is pristine, and be vigilant about checking it for these medical bills,” Mr. Rukavina says, adding that borrowers should also contact a medical provider’s office immediately after a visit to ensure that all bills outstanding are covered.

I just received this question from Bankrate.com and thought I’d share both the question and the answer, since this is a very relevant inquiry:

Question: With the practice of payment for deletion, a consumer agrees to pay a debt collector and the debt collector agrees to delete the collection account from the consumer’s credit report. Is it correct that a debt collector that complies with such a request would be in violation of the Fair Credit Reporting Act?

Answer: technically, yes. Under the Fair Credit Reporting Act, creditors are legally bound to accurately report a consumer’s known credit and debt activity, and this includes accurate reporting of negative, or derogatory, information. Debt collectors have the same obligation. 15 U.S.C. Section 1681s-2 (a) (1): “A person shall not furnish any information relating to a consumer to any consumer reporting agency if the person knows or has reasonable cause to believe that the information is inaccurate.”
Of course, any creditor or debt collector can determine that a derogatory mark is, in its own judgment, false, inaccurate or that cannot be verified. 15 U.S.C. Section 1681s-2 (b) (1) (E). In such a case, a creditor or debt collector can delete the derogatory credit reporting, but, to comply with the law, the creditor or debt collector would have to have a good faith basis for concluding that a derogatory is false, inaccurate or cannot be verified.

My firm has seen several cases where debt collectors specifically have promised deletion of a derogatory mark in exchange for payment of the debt. What the debt collector is not disclosing is that the debt collector may, in reality, be promising to cease reporting on its own reporting of the debt, but the debt collector has no ability to change the reporting from the original creditor. So, for instance, let’s say someone has a “Dinosaur” credit card which runs late and Dinosaur reports to the credit bureaus a 30-60-90 days late derogatory. Dinosaur then assigns or sells the debt to XYZ Debt Collectors. XYZ may tell the consumer that it will cease credit reporting the debt in exchange for payment, and in fact, in a misleading way, XYZ is telling the truth—it will cease its own negative reporting. However, XYZ does not disclose that it has no ability to affect any reporting being done by Dinosaur. Thus, the derogatory mark remains on the consumer’s credit. By law, it remains on the consumer’s credit report for seven years and six months following the date of first delinquency.

I have also encountered cases where the debt collectors simply lie to collect payment. Remember, the individual debt collectors are usually working on commission, and are given to lying, cheating and stealing to get the consumer to pay the debt. The individual collector rarely is the person at the debt collection agency who is responsible for changing credit reporting, which instead is a task usually given to someone in at least a supervisorial role. The individual debt collectors try just about anything to get the consumer to pay. It is the game. They can and will lie about credit reporting, and the only way a consumer will ever prove that they lied would be if the collector made the promise in writing. However, this will never happen—the promises to clean up credit will always be verbal only, because the individual collectors usually do not have the power to change credit reporting on the accounts.

Also, what debt collectors frequently do is simply to change the reporting from, say, “30-days late” to “settled for less than full amount.” The credit bureaus have created a special derogatory mark for consumers who negotiate down a debt—“settled for less than full amount”—for reporting on consumers who do not pay the full debt and/or who settle it for less than the full amount. This is considered a derogatory mark. So far as is known, it has the same effect as a derogatory mark for “30-days late,” so it makes little difference that a debt collector changes one derogatory for another. However, some debt collectors may believe that they are “cleaning up a consumer’s credit” by making this change. The proof is in the pudding, however—the consumer’s credit score will not change, or will change very little, when one derogatory mark is exchange for another.

So, if someone promises to “clean up your credit” in exchange for paying the debt in full, this promise is probably bogus.