The Problem of Relying on Credit Scores

Credit scores probably played a part in the lending crisis in 2008 because some lenders put too much weight on them, according to Bob Sullivan of MSNBC. Credit scores can be a helpful and efficient tool to weed out bad borrowers, but cannot replace informal judgments of character and other standard lending practices.

Imperfections

The current credit scoring standard as of 2011 -- the Fair Isaac Corp. or FICO model -- cannot incorporate many accounts because the major credit bureaus don't report them. Rent, utilities and cell phones rarely show up on credit reports because of the prohibitive cost to the provider and state privacy laws that restrict the sharing of consumer information. A lender that relies almost entirely on credit scores misses a significant portion of a borrower's credit history.

Overreliance on Scores

The traditional underwriting process requires legwork, such as verifying a person's income and checking character references. Running a quick calculation can entice lenders by slashing approval time rates, especially when loan officers make a commission on each mortgage sold. Also, credit scores only quantify a person's willingness to repay, so relying too much on a score omits another important part of a loan application -- the ability to repay.

Variance in Scores

Most consumers have different scores from each of the three major credit bureaus because of variations in the formulas they use and mistakes in picking up accounts. A consumer, for example, might have a collection account that only one of the bureaus knows about. A collection account is a seriously negative item, so this hypothetical consumer could have a good score at the other two bureaus and a poor one at the bureau that knows about the collection account.

Unethical Practices

Crafty consumers can trick the bureaus into removing an item to artificially boost their creditworthiness. A cottage industry sprung up around fixing credit scores, sometimes with illegal tactics, during the 1990s. Customers, for instance, can dispute any negative item and get lucky if the bureaus cannot verify it in 30 days. Credit repair companies may advise a consumer to use a fake Social Security number to start a new credit history.

Benefit

Reliance on credit scoring during the housing bubble motivated change in the standard credit scoring model. In 2008, for example, the a FICO formula was created to prevent most fraudulent authorized accounts from building a person's credit score. In previous years, credit repair companies often sold authorized accounts to help people start a credit history or rebuild one, despite having no connection to the primary account holder.