Your credit scores might go up this summer — and not because you've gotten better at paying bills on time. It's because of a change in the information used to calculate the scores.
The nation's three major credit reporting companies — Equifax, Experian and TransUnion — use information from public records about tax liens, civil judgments and bankruptcies when computing people's credit scores. But sometimes there are mix-ups, and the wrong person's credit gets dinged.
Now the companies have agreed to stop listing information about liens and judgments in credit reports unless they have certain data connecting the public record more solidly to an individual, according to the Consumer Data Industry Assn. (Bankruptcy records already have that data.)
The changes will apply to existing and new records, and they will take effect July 1.
How credit scores work
Equifax, Experian and TransUnion maintain credit files on about 220 million U.S. adults, according to the Consumer Financial Protection Bureau. They receive information on people's credit histories from a variety of sources, including banks, mortgage lenders, auto lenders, credit card companies, the education industry, collection agencies and debt buyers.
They also collect information from public records — state and federal tax liens, civil judgments and bankruptcy records — via third parties, primarily the data and analytics company LexisNexis Risk Solutions.
The credit reporting firms then match the information to individual people's files. Mix-ups happen when a lien or court judgment gets matched to the wrong person — for example, because of a common name or address.
The credit reporting companies use modeling software, such as FICO or VantageScore, to generate credit scores, usually between 300 and 850. The higher the score, the more creditworthy the person is. People's payment history (whether they consistently make payments on time), debt load and how long they've been using credit make up the majority of the score, said Barry Paperno, a former spokesman for FICO.
Lenders — including mortgage bankers, auto lenders, credit card companies and student loan institutions — rely heavily on these scores to assess how likely it is a person will repay a loan, and to set interest rates. Other agents, including insurers, landlords and sometimes employers, also access credit reports to set premiums or screen applicants, according to the Consumer Financial Protection Bureau.
A lien or judgment can harm your credit — and lower your chances of getting a loan
A public record appearing on a credit report can bring down an otherwise strong score by as much as 150 points, Paperno said. (People with otherwise low scores will not be affected as dramatically because their scores already reflect several red flags, so one more problem doesn't make them much riskier, Paperno said.)
The average American has a credit score of about 700, said John Ulzheimer, a credit specialist who has worked at Equifax and FICO. Mortgage lenders generally will not lend to someone who has a credit score under about 620 to 640. So damage to a person's credit score could derail the person's loan application or raise the interest rate on a loan.
Credit reporting firms no longer will be able to include information about tax liens or civil court judgments in credit reports unless those records include a name, an address and a Social Security number or date of birth to match them to a specific consumer file. The new standards also require the firms to update public record information in their files every 90 days.
About half of liens and nearly all civil judgments (96% of them) don't meet those identification criteria, according to LexisNexis Risk Solutions. Still, the information obtained from public records often overlaps with information from other entities, such as collection agencies or debt buyers, that still can be included in the reports, Paperno said.
FICO estimates that roughly 12 million people, or about 6% of the total scoreable population, will see increases in their FICO scores as a result of this change. The vast majority — nearly 11 million — will see a rise of less than 20 points, and about 700,000 people will see a jump of 40 points or more, according to a FICO analysis.
Consumer advocates say the changes are a win.
"In the end, [these changes] will benefit consumers because you want data to be accurate," said Chi Chi Wu, a staff attorney with the National Consumer Law Center. Wu said she knew of clients with common names who had been denied mortgages because their credit reports were corrupted by other people's data.
A 2012 study by the Federal Trade Commission found that 21% of consumers had a verified error in their credit reports.
This could put an extra burden on banks
Lenders agree that having accurate data from the credit reporting companies is a good thing, said David Stevens, chief executive of the Mortgage Bankers Assn.
"That being said, just because they didn't collect the [identifying] data doesn't mean that those aren't accurate credit failures of consumers," he said.
Stevens expressed concern that boosting consumers' credit scores without checking to see whether the underlying lien or judgment actually was accurate would lead to falsely high credit scores. "Borrowers who are just below the margin of approval … will get a free ticket to homeownership and mortgage approval when in reality their risk hasn't changed," he said.
Stevens, a former Federal Housing Administration commissioner, expected the changes to affect FHA loans the most strongly. These government-subsidized loans, which require lower minimum credit scores and are meant to help first-time and low-income homeowners, are more risky than mortgages given out by traditional lenders like Fannie Mae and Freddie Mac, Stevens said.
Banks have to certify to the FHA that information about their loans is accurate. If it turns out it isn't, banks can be forced to buy back the loan and pay damages. Many banks already have pulled back from FHA loans after dealing with lawsuits and billion-dollar settlements connected with underwriting problems.
"Will the lender now be held accountable for judgments and liens that have been eliminated for credit reports but [which lenders are] still obligated to report in their credit underwriting?" Stevens said. Having to collect and report public record information themselves would create additional costs, red tape and possible legal exposure for banks, he argued, giving them more reason to pull back.
Eric J. Ellman, interim president of the Consumer Data Industry Assn., said in a statement that credit reporting companies have carefully considered the effects of these changes on the public and on lenders.
"We believe the enhanced standards for public records carefully balance the concerns of consumers and regulators about public record accuracy while at the same time ensuring that creditors can continue to rely on credit report data and the credit scores derived from that data," Ellman said.
These changes follow several others
Consumer advocates have long lobbied for reforms of credit reporting procedures.
Before the federal Consumer Financial Protection Bureau began monitoring the industry in 2012, bureau chief Richard Cordray said this month, the three main credit reporting firms had "rudimentary or virtually nonexistent" methods for ensuring the accuracy of information and suffered from "badly broken" processes by which people could dispute information in their reports. Cordray said progress has since been made.
In 2015, under a settlement with the attorneys general of 31 states, Equifax, Experian and TransUnion agreed to stop including information about fines and tickets in credit reports. They also agreed to give people additional time to address outstanding medical debt.
The changes that kick in July 1 build on those earlier changes, announced as part of the National Consumer Assistance Plan.