Misleading free credit scores

Are Free Credit Scores Misleading?

Are Free Credit Scores Misleading?

For several years, many websites have offered free credit scores. Understandably, credit scores have a significant impact on consumers’ spending choices, possibilities, and habits. A credit score is a calculated number that is based on the information found in a credit report. Lenders use this information to determine if an individual’s likelihood of repaying a loan. Because consumers have multiple places to get their credit score, it begs the question: are free credit scores misleading?

In January, credit bureaus were forced to pay millions of dollars in fines due to their poor marketing. They failed to effectively explain the types of credit scores they offer. Ultimately, consumers created and implemented financial plans based on a credit score that were not used by lenders. Each credit bureau vowed to be more specific in the future, but until then, it is up to the consumer to educate themselves on the types of scores they receive.

Credit card companies use free FICO scores to provide credit scores on cardholder’s statements. Other websites like Credit Karma and Credit Sesame claim to offer free credit scores for those who sign up through the company’s website. At first glance, a person may think it is a legitimate way to get their credit score for free. However, many people do not realize that companies and bureaus can offer free credit scores if they are considered “educational scores.” These education scores are not used for decide whether a consumer qualifies for a service

It is important to note that there is not a single credit score for anyone. Each credit bureau creates an individual credit score based on the details from the credit report. So, what’s the difference between them, and which are some of the free credit scores misleading?

The Difference in Credit Scores

According to credit.com, a FICO score is a calculation based on “predictive analytics.” This means they use information obtained in a credit report to predict the consumer’s credit worthiness. While FICO itself is not a credit reporting agency, they pull details from Transunion, Equifax, or Experian to create a score.

Vantage Score is a model that was created by the three credit reporting bureaus. Designed to offer a competitive alternative for the FICO score, the score is used to give individuals an overall picture of their credit standing. It is ideal for those with little credit history. These reports are largely advertised at free or low-cost for consumers.

While many financial institutions and websites claim to offer free credit scores, it is important for consumers to understand that not all credit scores are the same. Several companies use various formulas to arrive at a final credit score. For example, Discover’s It Card uses FICO scores for its cardholders, while Credit Karma uses Vantage Score. Additionally, the three main credit bureaus use different computations and score ranges to give to lenders and individuals. Experian scores range from 330-830, Equifax scores are from 280-850, and Transunion scores range 300-850. This information is important because if the same person requests their credit score from each bureau, it is a strong possibility they will have a different score from each one. A score discrepancy of a mere 20 point could increase interest rates or result in a denial from a lender.

Perception Versus Reality

Consumers expect their credit score to reflect the information found in their credit report. However, since many companies can use varying criteria to determine a person’s credit score, details from the credit report are not evaluated the same. It is very common for the same person to have a FICO score that is significantly higher or lower than their Vantage Score.

There are countless amounts of people signing up for free credit scores under the assumption that all credit scores are the same. For the most part, all credit scores are computed based only on what the three credit bureaus report. The information is not weighed the same, causing different credit reporting companies to arrive at different numbers. For example, some educational scores may base their score on the last six months of credit activity, while a FICO score could be based on the last 2 years or more. Both credit reporting companies used the same credit reports for their scores, but the content of the reports were weighed differently. Many consumers do not know or understand this, and never see the credit report lenders see when they are applying for loans and credit.

Are Free Credit Reports Misleading?

Some credit monitoring companies work exceptionally hard to market their financial products to consumers. Television ads and sponsored web searches are glittered with promises from these businesses. Credit Karma is an example of a financial agency promising free credit reports and scores. However, it is not clearly advertised or explicitly stated that the credit score they provide is not the same as the score lenders use. Most lenders use FICO scores to evaluate a person’s credit. Like Credit Karma, many credit reporting companies do not disclose or clearly market their scores are different from FICO scores. Each year, banks can make millions of dollars due to “add-on” services. By offering a free credit score, they could persuade people to purchase other credit monitoring products. If it is not clearly communicated that the information and credit scores are not the same criteria used by lenders, it is misleading.

Which Type of Report Is Better?

Liz Weston, a Nerdwallet personal finance columnist suggests getting a FICO score if you’re going to pay for credit score. A FICO score is the best option if you are in the market for a huge purchase, such as a car or mortgage. Home mortgage companies still rely heavily upon FICO scores.

The Vantage Score is the most common score advertised in free credit score marketing. It’s ideal if a person wants an idea of how their credit is doing. Weston also points out that the FICO score and Vantage Score are different. However, the same behaviors, such as paying bills on time, can positively impact the score.

Obtaining a free score

Credit scores are different from credit reports. Obtain your credit score free of charge once per year from each credit bureau. Typically, FICO credit scores must be purchased. There are some circumstances in which a FICO credit score must be furnished without cost to the consumer. These situations include when:

  • A person is applying for a mortgage
  • A lender uses credit scores to determine pricing of a product, loan, or service
  • An individual is denied credit based on credit

If any of these situations occur, you should make a written request to ask which credit score is used.

Making financial decisions can be challenging, especially with myriads of products promising to have the most accurate information. When obtaining free credit scores, it is important to distinguish between a FICO score and newer alternative scores. Understanding the difference between scores could impact the next financial decision you make.

How credit scores are used: for example, to take out a home mortgage.

How Credit Scores Are Used

How Credit Scores Are Used

Understanding how credit scores are used is important for financial and life planning. From applying to credit cards to home mortgages to paying for school, credit scores are used in a wide variety of functions.

Why Are Credit Scores Used

Simply put, lenders want to do business with people who have a history of being responsible with their debt obligations. The three-digit number can affect how lenders do business with you in three main ways:

  • Whether you’re someone they’d like to business with
  • How much it will cost to do so
  • Which options lenders will offer you

Why are credit scores used as opposed to a different way of analyzing responsibility with debt obligations? Here’s a before and after of credit scores:

Before Credit Scores

Lenders used the applicant’s credit report to choose whether to grant credit before credit scores. A lender might have denied credit based on a subjective judgment. This method may have also been time consuming and subject to mistakes.  Lenders may have made decisions based on personal opinion rather than whether the applicant was able to pay back the debt.

The Emergence of Credit Scores

Credit scores started being widely used in the 1980’s. Credit scores help lenders calculate risk more fairly because they’re more consistent and objective. Your credit score simply reflects how likely you would repay debt responsibly, no matter who you are as a person. Credit scores are now dependent upon past credit history in addition to your current credit status.

Credit scoring 101

How is my credit score calculated?

The information that impacts a credit score differs based on which score is used. Overall, your credit score is affected by factors in your credit report including the following:

  • The total number of late payments
  • The severity of the late payments
  • Account age, number, and type
  • Total amount of debt
  • Types and number of recent inquiries

How Your Credit Scores Are Used

If you’re looking into getting credit, the following are some things you should keep in mind:

Applying for Credit Cards

Companies usually look at your credit score as one of many factors in figuring out whether to approve your credit card application. The formula each company uses is a heavily guarded secret.

  • The precise impact of your credit score will depend on which company is reviewing
    your decision
  • Your credit score may allow you to receive additional perks from a credit card company
  • Credit card companies can also use your credit scores to determine credit limits, interest rates, and other credit terms they offer you

Getting loans for school, a car, or a home

Many federal loans don’t look at your credit score. There are still some things to consider.

  • If you apply for a private student loan, however, banks typically are curious about your credit score and credit report history.
  • Your credit report and credit score also affect the loan approval and interest rate of the loan you’ll receive.
  • Auto lenders also look at your credit score to figure out if they will approve a car loan or lease.
  • Credit scores affect the interest rate in addition to the loan length.
  • The requirements for approval are usually stricter for mortgages.
  • Each lender will have their guidelines they’ll follow. However, it’s universal that your credit score is a significant data point that lenders will use.

Because of the latest housing crisis, some lenders may use the credit score as a higher factor in their analysis.

Other Situations

There are other situations where your credit score surprisingly plays a role.

  • Insurance companies are using credit scores to determine whether they want to provide coverage, how much they’ll cover, and how much they’ll charge.
  • This applies to home and auto insurance. When it comes to renting apartments, landlords often use credit scores to determine how much of a security deposit they may want from you.
  • If you need a payment plan to a buy a cellphone, companies may look at your credit score to figure out the type of payment plan options they’ll offer you and whether they’ll want a deposit.
  • Utility companies may take a look at your credit score to determine whether they want a security deposit from you and how much

How Credit Scores Benefit You

Finally, a way to understand how credit scores are used is to see how they benefit you and society as a whole.

Get loans approved more quickly

These days, the majority of credit decisions can be made in a matter of minutes. Credit scores allow department stores, websites, and additional lenders to make credit decisions almost instantly. Mortgage applications can be approved in a short-time frame hours as opposed to weeks.

Get fairer credit decisions

Things like gender, nationality, marital status, race and religion are not used in credit scoring. This allows lenders to be less biased and only focus on the relevant facts related to credit risk.

Credit mistakes are less important

Credit scoring doesn’t negatively impact you forever if you’ve had bad credit previously. More recent on-time payments will be in your credit report, while past credit problems fade away as time passes. Credit scoring takes into account a holistic view of credit-related information. Thus, your overall credit report is a much better view of your risk from the creditor’s perspective. This is in contrast to borrowers turning people down solely on a past problem in their files.

Obtain more credit

Credit scores gives lenders the confidence to offer credit to more people. This is because lenders have a better understanding of the risk they are taking on. Most lenders have their own individual guidelines. So, if you get rejected by one company, you can still get accepted by another. Instead of a simple yes versus no, lenders can offer a choice of credit products for different levels of risk. Credit scores allows lenders to identify more individuals to perform well in the future. This is true despite the fact that their credit report shows past problems.

Get lower overall credit rates

Automatic credit processes, such as credit scoring, allow for credit granting to be more streamlined and cheaper for lenders. The lenders, in turn, charge less for their service downstream to their customers. Lenders also control credit losses using credit scoring. This allows lenders to make rates lower overall. A great example is the fact that interest rates for mortgages are lower in the US compared to Europe. This is at least partially due to the fact that lenders have credit scores available to them.