It's the three-digit number that can make or break your ability to get a home loan, an apartment or even a job. But as Long Island debt consolidation attorney Leslie Tayne points out, "You can have a 750 credit score and not have 50 cents in the bank." So what does your credit score actually mean? What is a single point? And who decided that the major factors involved in formulating your credit score were what reflected who you are as a consumer?
Does a single point mean anything?
"I don't think anyone who is going to get approved at 620 will get turned down at 619," said Mike Sullivan, director of education with Take Charge America, a nonprofit credit counseling agency. Generally speaking, a one-point difference isn't going to make or break the possibility of a loan approval; nor will it make an appreciable difference in the interest rate you receive. "I don't think there's much chance of you getting a better rate even if you're just one point off," he says. Of course, Sullivan says that for certain mortgage products such as FHA loans, it's not even up to the lender. The rules are the rules, and if you're off by so much as one point from the required threshold, you're just not going to get approved for that loan. In that sense, a single point can be of make-or-break significance.
Why one point can matter
Sullivan further notes that there's a very good reason that, at least in terms of the interest rate, even a single point can make a big difference. Lenders need to stick to thresholds when deciding the terms of a loan to mitigate risk. So while a one point drop may not prevent you from getting approved for a loan, "lenders are going to be firm about even a single point when it comes to your rate."
All scores are not created equally
Of course, credit score calculations don't tell everything about a particular borrower. A one point boost to a certain threshold may be insignificant if there's a particular blemish on a person's credit history. Tayne raises the example of two different clients, both of whom have the same credit score -- but one has a tax lien. "Tax liens hang around even after they're released and they show that you have trouble meeting your obligations," she said. What this means is that the credit score, while to some degree a "gatekeeper" for certain loan services or even rates, isn't the end-all, be-all of loan products. The same two people can have the same two scores but be unable to access the same one loan service.
Who decided any of this stuff was important?
Randy Padawer, a consumer advocate with LexingtonLaw, provided insight into the origin of the five major factors determining credit score. "A long time ago Fair and Isaac were statisticians," he says. "They ran a whole bunch of what statisticians call 'Pearson Correlations' between events like paying on time or paying late or having a charge off."
Basically, what they found was that people with older credit histories tended to be better at paying back their debts. They found that people who applied for less credit were more likely to pay back loans. And so on. "The higher your credit score is, the more you look -- on paper -- like someone who is going to pay back a loan," he said. "That's all."
However, Padawer is quick to point out what he believes is the major problem with credit scores."They don't take into account the person who had decades of good credit, got sick for a year and had years of good credit after that," he says. "They consider patterns, not individuals." Still, potential lenders might be able to see that side of your story when they start digging around in your actual credit report.
A very common example of how credit scores can go wrong involves people in the military. "People who are in the military serving their country and risking their lives come home to find a stack of bills they didn't even know about," Padawer said. Federal law protects them, but a lot of times there aren't procedures in place to get things fixed. So even though they played by the rules, their credit rating is going to take a hit.
In the final analysis, a credit score can mean anything depending on who's looking at it. The problem, according to Padawer is that "it's designed to help lenders game the system in their favor." At the same time, he admits that without them, we couldn't have the kind of large-scale lending that drives the economy.