Banking on Higher Credit Scores

There has been an interesting debate online about the role that financial institutions should play in helping consumers repair their credit scores, and I thought I would weigh in.

The debate started here, with a blog post by Felix Salmon. From there, it moved to The Atlantic, where it has received a large number of comments this month.

For those who are not interested in reading the backstory, everything traces back to a college professor who took out a payday loan because her credit union would not approve her application for a personal loan. The authors of the two articles I linked to then begin to posit about the role financial institutions should play in helping borrowers improve their poor credit scores. Certainly, there is some value in having borrowers with higher credit scores. That usually points to people who are paying their bills on time. But should this type of goal be an explicit objective for a financial institution?

If this type of program were to be introduced, the most likely scenario has to involve the federal government. It is unlikely that the banking industry would gather itself and decide to make this a common goal.

Certainly, as was pointed out last week, credit scores are moving in the wrong direction, at least as far as banks are concerned. And credit scores are being used for far more than making decisions about creditworthiness. Companies are making hiring decisions based on credit scores. Insurance companies are using credit scores to determine how likely people are to be good drivers.

So, if the federal government is to get involved, perhaps the best way to tackle the program would be to create something similar to the Community Reinvestment Act, where financial institutions are required to make a certain number of loans in urban and low-income neighborhoods.

A brief aside: Every weekend, The Home Depot near my house holds free classes to teach DIYers (like myself) how to make basic repairs or improvements to our houses. It's a great idea, but The Home Depot's ultimate goal isn't totally altruistic. They are hoping to sell me more supplies and tools.

Should banks take lessons from The Home Depot? By helping borrowers repair their credit scores, would those borrowers be more likely to borrow again and again from that financial institution?

This is a very brief entry point into what could, and probably should, be a much larger debate about the role of financial institutions in an overall economy. But it's Friday and participating in an interesting mental exercise is a great way to kick off the weekend.

Should there be some kind of credit repairing system to help consumers get better rates? Isn't that in everyone's best interest?

Tags: credit, credit score, subprime

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Comment by ANDRES HUERTAS on January 27, 2012 at 12:53pm: Mike, the solution have existed for over 100 years, and its called Installment Lenders, installement lenders are generally regulated by the states and now by the CFPB; installment loans are offered in the form of personal loans and auto loans (direct auto loans where the customer goes direclty to the lender instead of the dealer), in general terms the loans are reported to credit bureau henceforth helping the consumer to improve the credit history if the loan is paid on time, also because of the nature of the loan (equal montlhy payments - no balloon payment), all lenders use underwritting paramenter to ensure approvals are based on credit history and the ability from the customer to repay the loan.

I disagree with you regarding having the federal government to require a lender to make x amount of loans in certain urban and low-income areas, just to educate you, when a direct loan is underwrittend where you live is not important, just your ability to repay and your credit history, to put in another terms, imagine if a lender is forced to borrow money to 1 particular block no matter what, you may have some people that may qualify and other may not but you are forced to give everybody money regardless, How this helps the financial system? How this will help the people that cannot afford to pay to improved their credit rating? And how this will help the people that can pay to get eaccess to cheaper credit since now they have to cover the losses for the people that cannot afford to pay back?

Making loans to people tht cannot repay not only will make credit more expensive but also will jeopardize the financial system, if you don't beleive that, just go few years back...

There is an organization that helps consumers keep informed about access to credit

http://associationforinstallmentlending.org/

Comment by Frank Rauscher on January 27, 2012 at 3:38pm: While credit scores have helped reduce the time it takes to underwrite credit, it is debatable that they have helped the middle class of our country. They have helped the "rich get richer and the poor get poorer".

They gave a false sense of security to pseudo-lenders and pseudo-investors and certainly to the regulators. Yet look at the chaos caused by credit of all types associated with some type of reliance on credit scores. And look at the dis-service to the middle class and lower class as other organizations start to use them.

When FICO first introduced them, the major West Coast banks were among the first to use them and found that the "rocket science" was not all that it was presented to be. Remember, using credit scores is like driving a car while only looking at the rear view mirror. What went wrong takes too much time to explain.

As for the government trying to "help" consumers? Other than fighting wars, there is little else that they do well. Dave Ramsey does more to help consumers than the government and the major banks combined! And he is getting rich while helping them! Yea for entrepreneurs!

Comment by Chas Roscow on January 30, 2012 at 5:46am: Frank makes a good point. During my days at Huntington Banks, I recall watching a presentation from Ann Tonks from SeaFirst in the early 90's - one of the first banks to rollout "Tier Pricing". The first thought that went through my head was "but the credit score is only one indicator of many" and will certainly cause excessive losses (due to false sense of security) on the lower scoring population and adverse selection and thin margins for prime lenders.

The best way for a consumer to enhance their otherwise dismal score is to add a comment to their credit bureau explaining their major derogatory references. Most consumers are not aware they have this option. Such an explanation may persuade the lender to make an exception to their written policy.

Comment by Frank Rauscher on January 30, 2012 at 9:55am: When FICO first introduced credit scoring in California, I one of ten credit administrators at the 10 largest West Coast banks (including SeaFirst) that evaluated it. When challenged, FICO admitted that the primary determinant of a good score at that time was owning a house in California for at least 5 years. Duh! Back then, anyone facing loss of income had a positive quick equity and could sell, payoff most debt and start with a new house. As FICO became more sophisticated in the quantitative math, they seemed to have lost that first basic lesson.

I am amazed that no lender has asked FICO for a performance guarantee on their product. If they really believed in it, why not guarantee it? Well, only the FED would have enough money to do that; but, isn't that reliance what many major credit providers have been banking on?

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