This post was co-authored by Jeff Shaffer and Doug Spak. It originally appeared on the RDS Blog and is republished here with permission.
Based on a March 2015 Settlement Agreement with the New York State attorney general, the country’s three largest credit reporting agencies (CRAs) agreed to overhaul their approach to fixing errors and their treatment of medical debts on consumers’ reports. The three-phase overhaul was scheduled to be completed by 2018.
In a related development in March 2017, the three leading CRAs-Equifax, Experian, and TransUnion-jointly announced that effective July 1, 2017, they will be limiting tax liens and civil judgment data in their reports.
In today’s post, we will take a closer look at this joint action and what it means to both consumers and lenders.
Anatomy of a Credit Bureau Report
The aforementioned Big 3 CRAs keep records on more than 200 million individuals influencing their ability to obtain credit. The data from the three CRA reports are factored into a consumer’s FICO credit score, which is ultimately used by most lenders to determine a loan applicant’s creditworthiness.
Following is an overview of what goes into a consumer’s credit report:
Otherwise known as the Credit Header, this is the identifying information for each consumer, including name, aliases, address, phone number, previous address, date of birth or Social Security number (SSN). Credit headers have been a source of controversy over the years because some of this customer information is sold in bulk for target marketing programs.
Credit reports also reflect information pulled from public records, including:
- Judgments from civil actions
- Tax liens from both state and federal authorities
- Bankruptcies, both Chapter 7 and 13
Credit History (i.e. trade lines)
The credit history is the centerpiece of a credit report and includes a breakdown of a consumer’s debt, including:
- Late payments (30 days and longer)
- Outstanding debt (the amount owed or size of the payment for installment loans)
- The total amount of credit currently available to the consumer (e.g., if you have a credit card with a credit limit of $8,000, even if you only use $1,000 of it a month)
This information appears for any institution that has extended credit to the consumer, such as banks, credit card companies, mortgage lenders, or auto-finance companies. This information remains on the credit report for seven years.
Inquiries and New Accounts
Businesses generate credit inquiry requests when they check a consumer’s credit worthiness. Inquiries may or may not affect a consumer’s FICO score. FICO scores reflect only voluntary inquiries prompted by a credit application. FICO scores factor in a variety of inquiries to a consumer’s credit score:
- The number of recent credit inquiries.
- Time since credit inquiry.
- A FICO score does not take into account any involuntary inquiries made by businesses with whom the consumer did not apply for credit, inquiries from employers or the consumer’s own request for a credit report.
FICO scores also look at the number of recently opened accounts and the time since those accounts were opened, in each case by type of account.
Credit Reporting: An Imperfect Science
Lenders use credit scores to make quick, uniform decisions about a consumer’s creditworthiness. A credit score plays a critical role in most lending decisions. Yet, according to a 2015 report by the FTC, one in five consumers has at least one error on one of the three major credit reports. Since 2011, the Consumer Financial Protection Bureau (CFPB) reports that approximately 8 million credit report disputes have been filed with the three CRAs.
To further complicate this issue, courts don’t record all identifiable information on all public records; for example, Social Security numbers or dates of birth typically do not appear in civil litigation records. As a result, the CRA may append civil litigation information to a consumer’s report based solely on the consumer’s name and address, which may result in civil litigation being reported against a consumer with a similar name to the actual litigant. Without information such as date of birth or Social Security number, it is difficult for the CRAs to distinguish betweenconsumers with similar names.
Because of these reporting challenges, there is renewed focus on improving standards for public record keeping. Most notably, they are pushing to apply better identity-matching criteria and updating records more frequently.
What the Recent Decision Means
The joint action taken by Equifax, Experian and TransUnion will go into effect July 1, 2017. To be clear, the CRAs were not required to drop public records data as a result of the 2015 NY attorney general settlement agreement. However, they were required to establish standards to ensure accuracy. Because most public records lack the consumer identifying information, such as Social Security number, the CRAs realized they wouldn’t be able to meet the accuracy standards, thus last month’s joint decision to remove a significant amount of tax lien and civil judgment data from their credit reports.
Judgments and tax liens are often the most negative items on a credit report. By dropping these public records, it is estimated that credit report scores could increase from 20-40 points for a portion of consumers for whom the CRAs have records.
Removing tax liens and civil judgments from credit scores will make risk assessment trickier for lenders. It’s not just that credit scores for many consumers will become dubious, possibly over-stating a consumer’s credit worthiness. It’s that consumers with liens and judgments are particularly risky (possibly twice as risky to default on loan payments based on various estimates). It will be impossible to tell two consumers apart based solely on their credit score. Let’s say two consumers each have scores of 700. One may have lots of public records and the other none. But they will appear to be equal in terms of risk. However, if the majority of the bad public records are now not reported or scored, the consumers who had previously had them on their credit report will suddenly be mixed in with people who have better credit.
It's Still About the Basics
Indeed, some consumers will benefit from the recent adjustments to credit reporting and scores by the major CRAs. But a solid credit score will still be tied to the same fundamentals that have guided credit worthiness for decades. Here’s a handy reminder of what one needs to do to improve and maintain a strong credit score: