The dysfunctional state of the US consumer credit-score model

The use of hundreds of credit-score models across U.S. means your score can swing by 100 points or more.

Ever stroll into a car dealership, confident your 720 credit score would earn you a great interest rate, only to find out that the figure the dealership pulled is 50 points lower than what your "free" credit report — or the free one provided to you by your credit card company — quoted you?

You're not alone. Many consumers cautiously monitoring their credit report are getting tripped up by lenders who pull figures contrary to the score on free reports.

Car dealership
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The reason for the discrepancy: According to loan industry experts, there are hundreds of different credit-scoring models circulating in the marketplace today, offered by the slew of credit and financial platforms advertising free credit reports. But the algorithms used by these companies aren't based on the same risk criteria as FICO, the model most often used by lenders to determine if a candidate is creditworthy and created and managed by analytics company Fair Isaac. As a result, scores can swing either way by a hundred points or more.

"Ninety percent of lenders use FICO," said Lisa Haydon, senior loan officer at Greenway Mortgage in Middletown, New Jersey. "When my clients get their credit reports through a [free credit platform], they don't use the same type of formula," she said. "They are angry when they learn that their 800 score that a [credit card company] quoted them is really only a 720 through myfico.com."

Consumers also need to understand that one score does not serve all purposes, Haydon said. Every consumer has three scores, one from each of the three major bureaus (Equifax, Experian and TransUnion). But that's a base score. Those credit scores will fluctuate according to the type of loan a lender is pulling your credit for, whether it's mortgage lending, auto lending or credit card lending.

That's because the algorithm used to determine an applicant's risk potential for a credit card is much different than the algorithm used to determine the creditworthiness of an individual applying for, say, a mortgage or an auto loan, Haydon said. So the free score you're provided is not accurate for all the sectors, she explained. When a lender pulls your credit, they pull it specifically for the type of loan you are applying for.

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"I tell clients I won't give them a preapproval letter off a quote from Discover, because the mortgage system and the credit card system is a different kind of animal," Haydon said.

For an added fee, myfico.com provides consumers with separate risk potential ratings for each of the sectors, she said, "but most people don't know to ask for this."

Credit management expert Diana Nichols, founder and president of Gold Key Consulting, agrees that the wide discrepancy across the credit industry is causing tremendous confusion — and anxiety — for consumers.

"There needs to be one standard," she said. "It's maddening. Consumers rely on the score they are provided and expect the interest rate associated with that score, only to be disappointed when their lender pulls a different number."

Millennials have lowest credit score of any generation
Millennials have lowest credit score of any generation   

Realizing the need for consumer credit consulting and education, Nichols started her Fairfield, Connecticut-based firm, in 1993 and over the years has gained a client base of hundreds of ultra high-net-worth clients. Although consumers are more empowered now that credit scores are finally being made available to the public, she said, people are still struggling, trying to figure out how to become truly savvy when managing their credit and applying for a loan.

"It's maddening. Consumers rely on the score they are provided and expect the interest rate associated with that score, only to be disappointed when their lender pulls a different number." -Diana Nichols, founder and president of Gold Key Consulting

"In today's marketplace, 10 points can change your interest rate substantially," she said. "If you're a 710 instead of a 720, you could end up paying another $70 on your car loan every month."

Nichols says that overall, the credit-scoring system today is a confusing quagmire of inconsistencies, and the consumer invariably gets caught in the middle. "There's always some new spin that throws everybody off, and it's almost impossible to navigate unless you are truly educated on all the nuances," she said, adding, "Most people give up due to time constraints, too much frustration and not enough experienced credit consultants in the field."

Understanding how the credit system works and knowing which questions to ask a lender before signing the loan application could increase your score — and your purchasing power. Here's what Nichols suggests:

The 5 credit score steps you need to take

1. Ask lenders which FICO version they use. Almost all lenders use FICO when pulling credit reports, but within FICO there are seven different versions, said Nichols. Although FICO rolled out their latest version, FICO 8, in Spring 2014, many mortgage lenders haven't yet updated to FICO Score 8. So most mortgage lenders are still pulling numbers based on FICO's previous versions (Equifax uses Score 5, TransUnion Score 4 and Experian Score 2). Myfico.com will provide your Score 8 as well as other versions. If you ask the lender which version they are basing their decision on, you can follow a set of instructions to work toward increasing that score (see below).

2. Use the simulator to increase your score. Each version contains an algorithm that analyzes your credit score. If you understand the factors that go into the algorithm, then you will be armed with the power to increase your score. The caveat: Every version contains its own algorithm. What works to increase your score for one version may not work for another.

"Myfico.com provides a simulator for each version, instructing you on what to do to increase your score, such as paying off credit cards, closing out cards or paying down debt," Nichols said. But the simulator for each version is different. "If you follow the simulator instructions for the wrong version, you could lower your score considerably," she said.

For instance, Nichols said that in FICO 8, you can increase your score if you pay off any accounts that are in collections. This isn't true for FICO's older versions. "Every version contains different nuances for increasing your score," she explained. "It's important to understand what they are. In version 8, points are no longer given for being an authorized user on an account that's in good standing."

3. Request the scores for each sector. "To be truly savvy, you must know the score for the type of loan you are applying for," Nichols said, explaining that for an added fee, FICO will provide industry-specific scores from the three bureaus — for auto lending, mortgage lending and credit card risk. Most auto lenders rely on the FICO Auto Score, for instance, rather than the basic FICO score.

4. Use the scores to your advantage. If you are applying for an auto loan, look at the scores from each of the bureaus. "If one of the bureau's scores is considerably higher than another, you can utilize it to your advantage," Nichols said, explaining that not all car companies use the numbers from all three bureaus. "Some car companies use only Equifax; Toyota and Lexus use TransUnion and Experian. So if the Equifax score is really low, you may want to shop at Toyota."

5. Ask your lender which score they use. Often, mortgage lenders will throw out the highest and lowest and go with the middle score. They never average them out. Scores between the bureaus can fluctuate wildly, as not all collection agencies and creditors report to all three agencies, Nichols explained, adding, "Many collection agencies report only to Experian, so that bureau tends to list lower scores."