The whole credit score model is 'ridiculous'

  • The Equifax data breach should shine a light on the faulty methodology all the ratings agencies use to create credit scores.
  • These scores, based on convoluted calculations, make little financial sense in many regards.
  • The whole system is "crazy." We need more innovative ways to assess financial responsibility and creditworthiness.

Certainly, with the recent breach of their data and executives jumping ship, to say Equifax isn't popular might be the understatement of the century. In fact, when asked for comment on the company, Andy Swan, founder of LikeFolio, a technology company that uses social data about consumers to produce investing insights, told me that Equifax is one of the most hated companies in the LikeFolio universe, posting worse consumer happiness scores than United Airlines after their recent incident involving a man being dragged from a plane.

However, apart from the direct impact of having sensitive personal data exposed—data that wasn't even given to the company by the consumers—consumers have another beef with Equifax and its counterparts and that is its shoddy business methodology and model.

Credit scores lie at the center of Equifax's model, both directly by providing them to would-be lenders and indirectly by allowing consumers to monitor those scores. However, these scores don't make a lot of financial sense in many regards. Based on their convoluted calculations, a very wealthy individual that doesn't use credit often could have a lower credit rating than someone who has few assets but lots of credit with low utilization.

From Equifax's own website, it lists the factors used to calculate credit scores as:

  • The number of accounts you have
  • The types of accounts
  • Your used credit vs. your available credit
  • The length of your credit history
  • Your payment history

Notice no mention of details you might find important in finding someone creditworthy, like say, their net worth-and this is the crux of the issue.

"Consumers don't trust credit rating agencies and don't want their financial freedom impacted by a score that can be artificially raised by something as silly as opening a third credit card account they don't want," Swan said.

And it is ridiculous. An article at Bankrate talks about how your score is impacted by the amount of credit you have versus how much you use. This is a fancy way of saying take on credit but don't use it. The article goes on to say, "Even if you're paying balances in full every month, your credit score will still weigh your monthly balances" and then suggests that maybe you could pay down your balance in chunks during the course of a month!

If this all sounds like a game to you, you are not crazy, the system is. While financial services companies are often slower to adopt innovation, it's clear that the one possible bright spot that could come from the Equifax mess could be to highlight how out-of-touch and out-of-date these current credit scores and agencies are and create a desire for more innovative ways to assess financial responsibility and creditworthiness.

Fiscal responsibility is inconsistent with taking on any more credit than you need. Let's push for creating rankings that look at the whole, not a skewed part of your entire financial situation.

Commentary by Carol Roth, creator of the Future File® Legacy Planning System, "recovering" Investment Banker and bestselling author. Follow her on Twitter @ caroljsroth.

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