Donna and Garry Blake make a good living, own a home and always pay their bills on time. So the couple was 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 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.
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, but 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.
Insurers are beginning to use scores to set premiums for car and homeowner policies. Health-care providers pull scores on their uninsured patients to decide who gets billed and who must pay the receptionist up front. And the Internal Revenue Service uses scores to decide which taxpayers to audit.
“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.
“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.
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, according to 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, San Francisco-based Greenlining Institute 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.
He complained scoring often puts computer analysis over common-sense judgment. For example, his group has seen minority applicants rejected for home loans due to poor scores even when their expected monthly house payments would be less than the family’s current rent payment.
Banking regulators are also 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.
At the urging of Freddie Mac and Fannie Mae, Fair, Isaac’s credit bureau scores, also called FICO scores, are now pulled for virtually all home loans, though most lenders do not use them as the sole factor in judging whether to approve or deny a mortgage.
Nevertheless, brokers are struggling to make sense of some scores, which often appear to make little sense.
For example, the FICO scores for borrowers with no charges on their credit cards will likely be worse than scores for similar borrowers who have moderate debts levels. That’s because the computer assigns a greater risk to a borrower with untapped credit lines, fearing the person might go on spending spree.
Or an individual who has never missed a payment in 30 years but recently opened a couple of new credit cards and bought a new car could easily fare worse than a neighbor whose car was repossessed five years ago. That’s because the computer is likely to be more concerned about the recent inquiries on the credit report than the credit blemishes from several years ago.
“Sometimes it just doesn’t make sense,” said Jeff Lazerson, president of Portfolio Mortgage in Lake Forest, Calif.
