MyFICO, Myself

I’m going to go out on a limb here and say that some people need to stop worrying so much about their credit scores. When did credit scores become an obsession? If I see one more article about how people spend hours each month trying to “game” the model to drive their score up a few points, I am going to tear my hair out.

Look, I understand that a higher credit score can save thousands (or tens of thousands) over the course of a major loan such as a mortgage. I’m not saying that the number is unimportant or that we should ignore it.

My point is that I feel like people have a tendency to become overly distracted by their credit score. This distraction can constitute a relatively benign waste of time or may range all the way to financial paralysis or even self-destructive behavior.

For example, I’ve met with several people who have been under terrible duress with their credit cards: late payment fees, default interest rates in the 30-percents, collection calls coming non-stop. But these people are too afraid to take action (contacting a credit counseling service about a debt management plan or even learning more about bankruptcy protection) because they’re irrationally concerned about the effect these actions might have on their credit score.

At the other end of the spectrum there are people like Jeffrey Sheldon (from the credit score article referenced above), a 36-year-old systems administrator in Virginia, who is taking great pains to bring his 740 credit score even higher in hopes of qualifying for the best terms on a planned home refinance:

When Mr. Sheldon was shopping for an auto loan last fall, he first compared rates online. Then, he allowed only two lenders to pull his credit report because he know that lots of inquiries could drag down his score. Now, he's making extra payments so that he can pay off the five-year loan in 3 1/2 or four years. He figures the low debt level will boost his score, which is already near the upper end of ... the range.

I applaud Mr. Sheldon for doing what he can to save money and reduce his debts. But I see a lot of people who go through these same efforts who are not even planning to take out a major loan in the near future. They want a higher score simply because they see it as some sort of personal validation.

The credit score is tantalizing because it pushes specific psychological buttons. It is seen as completely empirical measure of our behavior (ha!) that provides feedback about our actions. It presents an individual “score” (double ha!) based on that behavior. The score categorizes and ranks us. Additionally, there is the reward for a good score that comes in the form of better terms on loans and therefore saved money (just tell that to all of the borrowers with good credit scores who still got subprime loans).

Let’s take a minute to address these assumptions. First of all, the credit score is not a measure. It is a model. It compares specific financial behavior against the behavior of others in order to predict the likelihood that a person will default on a payment. Period. It doesn’t measure how “good” or “bad” you are with credit – it simply lets lenders know how they can best make money off of you. If you get a high “score” (I’m going to force myself not to put that word into quotes for the rest of this piece even though I’m tempted to – indulge me just this once) lenders know they can make money off of you slowly over a long period of time. If you have a low “score” (okay, I promise that’s the last time) then they need to make money quickly before you are statistically likely to have trouble making the agreed-upon payments.

Why are credit scores so commonly misunderstood? Why are they so broadly applied outside of what the model is designed to capture?

I think people get distracted by their scores because humans are social creatures and thus hard-wired to crave feedback and validation from external sources. Credit scores can seem like the ultimate measure of all the things adults strive to be– mature, trustworthy, and responsible.

A high credit score can also serve as a psychological balm during insecure times or when facing a daunting challenge. It’s as if you say to yourself, “See – Fair Isaac Corporation thinks that I’m going to be financially stable enough to make these payments for the next 30 years. I’m going to believe that, too.”

The reward that we get for having a high score can indeed be of significant monetary value. But the more we try to game the score the more we pervert the validity of the model. This touches on the Observer Bias, where people change their behavior when they know they’re being watched. The Observer Bias can skew the results to the point where the validity of the measure (model) is ruined and must be revised.

Overemphasis on score is also problematic when people focus on the number to the exclusion of the good behavior it is supposed to measure. When we don't take the actions that we need to (such as accepting a short-term dip in score in order to address a pervasive debt problem) or when we lose significant amounts of time or quality of life in order to game the system, then I think we have lost sight of what's important.

Remember that the actual scoring algorithm is kept completely confidential so at the level of specific action we can't even know for certain how our behavior will change the score. For the vast, vast, vast majority if we just pay our bills on time, live within our means, only take out the amount of credit that we can manage, and check our credit reports for errors, then our scores should reflect that we are capable financial stewards without any more self-conscious forms of management.