Donna and Garry Blake make a good living, own a home and always pay their bills on time. So the couple were more than a little surprised recently when they were turned down for a small home-equity loan they wanted for some new living room furniture.
Why did First Pacific Financial of Costa Mesa, Calif., reject them? Their "score" was too low.
"The loan officer said our credit was just fine, but the score was not right," recalled Donna Blake, who owns a small construction business with her husband in Oregon. "I didn't even know what a score was. It made me feel like a number. And there was nothing we could do about it. No place to call and explain. Our loan was just dismissed."
Welcome to the brave new world of consumer lending. It's no surprise that the days are long gone when tellers knew customers by name or George Bailey-type bankers saved the town as in It's a Wonderful Life.
But even the most cynical consumers may be shocked to learn how many day-to-day decisions _ once based on face-to-face relationships and human judgment _ are now determined by computerized scoring models that strive to boil down the essential facts of a person's life into a simple number. Not since your college entrance exams has a score been so important to your future.
Scores _ typically based upon the information in your credit report, including past bankruptcies, late payments and total debts _ not only determine whether your credit-card application is accepted, they are routinely used by banks to raise or drop interest rates for existing cardholders or decide whether to grant credit-limit increases.
A good score can get you a mortgage approval in minutes; a bad one can lock you out of the best rates, generate a pile of paperwork and require weeks of waiting. When you miss a payment, your score can mean the difference between a friendly reminder letter and a nasty phone call demanding payment.
Insurers are beginning to use scores to set premiums for car and homeowners policies. Health-care providers pull scores on their uninsured patients to decide who gets billed and who must pay the receptionist upfront. The Internal Revenue Service uses scores to decide which taxpayers to audit. And there have even been scoring models used to select which prisoners to release early.
"We are going to continue seeing an increase in computers making decisions," predicted Lawrence Lindsey, an economist at American Enterprise Institute and a former governor of the Federal Reserve Board.
Lindsey knows firsthand how the influence of scoring has grown. Two years ago, the former Bush administration adviser was rejected for a Toys R Us rebate credit card because a computerized scoring system deemed him too high-risk. Despite his $123,100 annual income and clean credit record, the computer rejected Lindsey because too many companies had requested copies of his credit report during the previous six months.
It turned out that Lindsey had simply refinanced his mortgage, moved a home-equity loan to another bank and applied for one credit card. But the scoring model interpreted those inquiries as a sign that Lindsey might be desperate for new lines of credit.
That a top banking regulator could be rejected for a credit card was an embarrassing setback. After widespread publicity, the credit card company, Bank of New York, eventually offered Lindsey a card. But the incident hasn't slowed the growth of scoring, which is now poised to move into the utilities and telecommunications industry.
To critics, scoring represents an Orwellian nightmare where individuals are reduced to numbers and decisions are made solely because the computer says so. Big Brother is not only watching; he's keeping score.
But supporters say scoring technology is not only faster and cheaper than using humans to make decisions, it can also put more credit in the hands of borrowers who need it and virtually end discriminatory lending practices. Since scores do not take into account factors such as sex or race, the models are theoretically color-blind. Borrowers are no longer at the mercy of a loan officer who may not like their skin color or the way they dress, or who had a fight with a spouse.
"It works better than the old way, when people would rely not on facts and data but on subjectivity and gut feelings," said Larry Rosenberger, chief executive at Fair, Isaac & Co., the nation's leading developer of scoring models.
Bonnie Schwartz, a small-business owner in Tampa, agrees. Hoping to move her focus-group company into a larger facility, Schwartz turned to her local bank for a loan. She presented the lender with a business plan and balance sheets that demonstrated her company's success. But the loan officer had only one question: Hadn't Schwartz received control of the business through a divorce settlement?
In fact, Schwartz had launched her company five years after her divorce, working 14-hour days at her kitchen table. Her ex-husband had no role whatsoever. But it was no use explaining. Schwartz said the bank viewed her not as a businessperson, but as a divorced female. She was turned down. A second lender offered a $2,500 credit line, but it was hardly enough to buy a new facility.
Eventually, Schwartz turned to Barnett Bank, which used a scoring model for small-business loans. Within days, Schwartz had $50,000 for expansion.
"In the South, you still run into a good-old-boys network," Schwartz said. "I wasn't going to be able to change that. But with scoring, they just look at your record. It isn't sexist or discriminatory."
For small businesses, scoring has been nothing short of revolutionary. In the old days, entrepreneurs had to spend precious hours away from their business, visiting loan officers with hat in hand and filling out reams of paperwork. Today, scoring is allowing banks to say "yes" faster and more often, said Marc Bernstein, senior vice president of Wells Fargo's small-business lending unit.
Still, the increasing reliance on scores has sparked criticism.
Though Freddie Mac and Fannie Mae say their research shows that scores do not discriminate against minorities, the Greenlining Institute of San Francisco blames scoring models for a recent reduction in loans made to African-American and Latino borrowers in California, said Bob Gnaizda, policy director for the consumer group. Because minority borrowers have thinner credit records, they tend to receive lower scores, even though they may be good risks, Gnaizda said.
Banking regulators also are taking note. In a formal warning in May, U.S. Comptroller of Currency Eugene Ludwig said federal examiners were seeing potential misuses of scoring that could result in discrimination against borrowers or threaten the safety of banks.
The comptroller's office is less concerned that the models themselves are faulty or discriminatory. Rather, the regulator wants to ensure that the humans who are implementing the scoring techniques are adequately trained to deal with the new technology in a responsible manner, said Dave Gibbons, deputy comptroller of the credit division.
"It's a matter of how you use it," Gibbons said.
How to boost your rating
How can you increase your credit-rating score?
Based upon studies by scoring company Fair, Isaac & Co. and interviews with brokers who work with the scores every day, here are some tips:
PAYBACK: The biggest factor is the borrower's past payment history. Bankruptcies, foreclosures, collection accounts and delinquencies will take a bite out of your score. Get a copy of your credit report and clear up any mistakes.
DEBT LEVELS: How much debt you carry on your credit cards and other accounts is the second-biggest factor in determining your score. The model compares your total debt to the total credit limit of your accounts. If your total debt is more than 75 percent, your score likely will suffer.
ZERO BALANCE: Having no balance on your credit cards won't help your score. In fact, consumers with zero balances can get lower scores than those with moderate balances. Lenders fear that zero-balance borrowers have greater potential to get into trouble by going on a spending spree. However, the models appear to reward borrowers who have at least one credit card with no balance. So closing some dormant accounts and consolidating debt onto fewer cards may help, as long as you don't get too close to the card's limit.
CARD SHARKS: If you're playing the rebate game by charging all your purchases in order to earn airline miles or other reward points, your score may suffer. That's because scoring models don't distinguish between a $5,000 credit card balance that revolves from month to month and $5,000 in debt that is charged each month and paid off immediately. If playing the rebate games takes your credit card balances to their limits each month, your score will pay the price.
STUFFED WALLET: The risk is higher (and scores are lower) for consumers with no bank credit cards or those with five or more bank credit cards. Two to four cards seem to be a good number. But if you decide to cut up some cards, be careful not to close older accounts. Your score is also affected by how old your accounts are.
AGE PAYS: The longer your credit history, the better your score.
SHORT-TERM MEMORY: More recent black marks are worse than problems that occurred years ago. Problems more than 2 years old likely won't hurt your score as much.
INQUIRING MINDS: An inquiry into your credit report occurs when you apply for a loan or credit card and a bank or lender reviews your credit record. Too many inquiries in a short period of time may signal that a consumer is actively seeking credit because of financial problems. According to the score models, the risk of default appears to rise after two to four inquiries within six to 12 months.
Be selective about whom you allow to pull your credit report.
Fair, Isaac has attempted to alleviate concerns by limiting inquiries' effect. For example, several inquiries made by lenders or car dealers during a seven-day period will be counted as a single inquiry. Also, inquiries are not counted when consumers check their own credit report, when existing lenders do periodic checkups on their borrowers or when banks preapprove consumers for credit cards.
JUST SAY NO: Opening several new credit card accounts in a short period can hurt your score. The damage is even greater if you have high balances on those new cards. This can hurt consumers who shift their credit card balances from card to card every six months to take advantage of teaser interest rates.