Thanks for this history. I've been looking for why FICO (Fair Issac Corp) started this formula for consumer credit. The reason I'm seeking an answer to "why" is because it seems the formula is more beneficial to the lender (obviously), but almost too beneficial. Here's why I say this.
When a poor credit risk is identified, instead of having their credit "cut off" automatically, many times they are charged a higher interest rate. This creates a situation where they will owe more money. If they initially had a problem paying their debts, then how does charging them more money help them - or the lender? A poor payment history and a large amount of debt is 65% of their FICO score - only 10% of their score weighs the amount of credit the APPLY FOR! Wouldn't increasing the percentage of the latter help reduce an individual's risk of building a large amount of debt? No credit, no charging. It makes sense to me, but it seems that banks would no longer make the money they are making now off of these individuals. So the solution to me is to simply cut off a person's credit when they begin seeking too much credit. This will prevent debt from accumulating. The way it is set up know allows a poor credit risk to build debt and never be able to pay it all off (just minimum payments, which we know is the kiss of death).
So the FICO score is designed to unfairly benefit lenders by allowing poor credit risks to saddle themselves with debt.
Has there ever been a movement to change up this percentage?
thanks - edited to remove a full name.
@Anonymous wrote:Thanks for this history. I've been looking for why FICO (Fair Issac Corp) started this formula for consumer credit. The reason I'm seeking an answer to "why" is because it seems the formula is more beneficial to the lender (obviously), but almost too beneficial. Here's why I say this.
When a poor credit risk is identified, instead of having their credit "cut off" automatically, many times they are charged a higher interest rate. This creates a situation where they will owe more money. If they initially had a problem paying their debts, then how does charging them more money help them - or the lender? A poor payment history and a large amount of debt is 65% of their FICO score - only 10% of their score weighs the amount of credit the APPLY FOR! Wouldn't increasing the percentage of the latter help reduce an individual's risk of building a large amount of debt? No credit, no charging. It makes sense to me, but it seems that banks would no longer make the money they are making now off of these individuals. So the solution to me is to simply cut off a person's credit when they begin seeking too much credit. This will prevent debt from accumulating. The way it is set up know allows a poor credit risk to build debt and never be able to pay it all off (just minimum payments, which we know is the kiss of death).
So the FICO score is designed to unfairly benefit lenders by allowing poor credit risks to saddle themselves with debt.
Has there ever been a movement to change up this percentage?
Welcome to the forums!
I think there's an assumption here that FICO is the final arbitor with regards to credit. It's not. If you look at your soft pulls within your CR, you'll find that many of your creditors are looking at your report monthly, for the most part, and others less frequently. They are looking to see if you are adding more credit while keeping balances on your existing accounts, if you are late, how you utilize the balances you have, etc. While a FICO score can be generated off a soft pull, lenders don't always look at that. For example, Barclays is known to close their account with you just because you added more credit cards. The Hooters CC has been known to close your account just because you added a mortgage. You can also have high balances with FICOs in the 700s, and still face CLDs just because your lenders think your utilization is too high. In each of these examples, FICO can remain high, relatively unchanged in many cases, but still face adverse action based on non-FICO info.
As for increasing the APR, it's up to the debtor whether or not they want to charge more. They can opt to pay it off, shelve it, etc. Adding more credit by that person won't get them any further out of debt. In fact, you aren't likely to get approved if you are defaulting anyway and CCCs have been known to cut your limits if the balances are too high, you aren't paying it off fast enough, etc. That's based on what the creditor sees in their own records or via soft pulls. The moment you have a late payment showing is the moment all future credit stops anyway (except for a few trash cards). And if you are late, your CCCs won't let you charge anyway until you are current once again. That's not a function of FICO. And if a debtor gets to a point they can't pay a CC, that's their own doing. Even if you immediately stopped all credit access as proposed, the balances will still get higher and higher if they aren't paying.
BTW, I think the score should punish you more for higher debt. IMO. That 30% or 35% should bump up, not down.
It took a while to read the OP and the two replies, but I have to say, Wow!!!!
That was a great read, very educational, I am so glad this post was resurrected and I found it, most likely one of the best posts I've ever read, I found myself trying to imagine what it would have been like in the early days described in the post.
Thank you Tuscani for posting this, what a wonderful post.
@ scarolan & IIecs, great follow ups to the OP, I enjoyed reading your replies as well, just an overall perfect Thread.
I'm not sure that you're understanding what my question is. My concern is that a lender will decide the interest rate on the debtor due to a low FICO score. A low FICO score, more times than not, inidcate a person who is struggling with finances. A debtor may get desparate and think that more credit will help them out of their situation. Once they do this, they are approved and charged a large interest rate, all the while they are paying a minimum payment that will never get them out of debt.
My question focuses on the potential for abuse by new lenders to charge high interest rates on drowning debtors who are still able to attain credit (because they pay their minimum payments). Payment history doesn't catch a person who pays the minimum payment and cannot afford more credit. Payment history simply shows someone who can pay a minimum payment. Stopping new credit can prevent large debt from accumulating.
Thanks for the quick response.
An excellent article!
For those who still have the thirst for history and would be interested in a paper that details the workings of the CRAs and led up to the enactment of the new Direct Dispute process, bypassing the CRA dispute process, I suggest the following very detailed analysis, which can be obtained by a quick Google on the name of the submitter, Leonard A Bennett:
Testimony
Before
Subcommittee on Financial Institutions And Consumer Credit
of the
COMMITTEE ON FINANCIAL SERVICES
Regarding
"Fair Credit Reporting Act: How it Functions for Consumers and the Economy"
June 4, 2003
Submitted by: Leonard A. BennettLeonard A. Bennett, P.C. 12515 Warwick BoulevardNewport News, Virginia
Edited to remove contact info
on behalf of
National Association of Consumer Advocates
@Anonymous wrote:I'm not sure that you're understanding what my question is. My concern is that a lender will decide the interest rate on the debtor due to a low FICO score. A low FICO score, more times than not, inidcate a person who is struggling with finances. A debtor may get desparate and think that more credit will help them out of their situation. Once they do this, they are approved and charged a large interest rate, all the while they are paying a minimum payment that will never get them out of debt.
My question focuses on the potential for abuse by new lenders to charge high interest rates on drowning debtors who are still able to attain credit (because they pay their minimum payments). Payment history doesn't catch a person who pays the minimum payment and cannot afford more credit. Payment history simply shows someone who can pay a minimum payment. Stopping new credit can prevent large debt from accumulating.
Thanks for the quick response.
I understand completely what you are saying. But banks, credit card companies, auto lenders, mortgage lenders are all out to get money. The lower the score, the higher the interest, the more money they get. They aren't your best friend looking out for your own good.
@Anonymous wrote:I'm not sure that you're understanding what my question is. My concern is that a lender will decide the interest rate on the debtor due to a low FICO score. A low FICO score, more times than not, indicate a person who is struggling with finances. A debtor may get desperate and think that more credit will help them out of their situation. Once they do this, they are approved and charged a large interest rate, all the while they are paying a minimum payment that will never get them out of debt.
My question focuses on the potential for abuse by new lenders to charge high interest rates on drowning debtors who are still able to attain credit (because they pay their minimum payments). Payment history doesn't catch a person who pays the minimum payment and cannot afford more credit. Payment history simply shows someone who can pay a minimum payment. Stopping new credit can prevent large debt from accumulating.
Thanks for the quick response.
Your solution to the problem although noble (well intentioned), would create the following situation. A person might be having a temporary set back and need to borrow more money but is willing to pay the interest, tighten his belt, work twice as hard, and work his way out of debt. He still needs operating capital to continue without defaulting on some bills and having his credit trashed for possibly 7 years. You would have the banks or society protect him from himself by cutting off all credit because he is STARTING to APPEAR like a risky borrower.
Cutting people off from credit at the early "risky" stage would be like telling them to default now and try to rebuild credit again in a few years. The existing system mitigates the risk that person might present to lenders who don't suddenly cut him off from credit. All people at his "risk" level, are pooled and charged a slightly higher interest rate so that the lenders are compensated for the 5% or so people (who are at his risk level) who will eventually actually default on their debts.
Some people work their way out of debt from the above mentioned level of risk, and eventually get somewhat lower interest rates. Others end up going deeper into debt and now have a higher chance of defaulting. At that risk level 10% of the pooled risks are projected to default so the interest rates are raised again to cover costs of the projected defaults. At some point some people do go all the way down the slippery slope to higher and higher interest and eventually BK.
At least under the current system people have choices. By trying to protect people from themselves presumably by more laws, one denies credit to people who only have minor setbacks and are willing to do what it takes to work out of debt.
Sure the system is abused, especially by the banks. It is however what it is. If we try to radically change it, the lenders will find new ways to maximize their profits. When that happens those who can least afford it will be hit with additional fees and higher ongoing interest rates.
The problem is not the lenders. It is human nature. If a person has financial misfortune and needs to cary any debt at all, that person should realize that living debt free should be the goal no matter what it takes. Temporary debt is necessary at times, and the interest rate incurred by temporary debt is relative low. Long term debt is simply a situation of the borrower being slave to the lender. The longer and deeper a person is in debt, the higher the interest cost.
I agree with your premise that lowering interest rates may help some people get out of debt faster. Unfortunately most will simply use the lower cost of borrowing to excuse racking up more debt. The banks are in business to make money, not help people out of debt.
Simply out the banks make money from people who pay them. A certain percentage will end up defaulting (not paying). The banks just play the odds. Lend to more people who will pay than won't pay. In the end FICO scores are just the "odds that a creditor will be repaid". At a race track you can bet on a favorite or a long shot. When a bank bets on a favorite with a high FICO score and low outstanding debt the bank is willing to accept a smaller pay off. If the bank is betting on a 100 to shot (low score high debt), the bank wants a higher pay off if it actually ever gets paid all that it is owed.