There’s never a shortage of credit scoring myths and misconceptions, and we only had enough space in last month’s issue of The Score to debunk two of them, so this month we’ll tackle two more.
Myth: One seriously derogatory item is worse than another
It’s not uncommon for me to hear either court testimony or read blogs about credit scoring that attempt to quantify the influence of negative information on a consumer’s credit scores. One of the more common mistakes that people make when addressing the issue of “score impact” is trying to assign value to one seriously derogatory item versus another.
A seriously derogatory item or “major derog,” in the world of credit scoring, is any item that is 90 days past due or worse—and “worse” includes things like collections, repossessions, foreclosures, bankruptcies, defaults, settlements, past-due accounts, judgments and liens. (For more details on “major derog” credit file entries and how to avoid them, see our “Steer Clear” article series.) In terms of credit score impact, all of the above mentioned derogatory entries are equal.
Take a minute to digest that because it can be hard to believe that a bankruptcy filing is considered an equally derogatory entry as an account that is 90 days past due. The inevitable follow-up question is, “Why would all of those things be equally problematic entries?” The answer is because credit scoring systems are built to predict the likelihood that you’re going to go 90 days past due on any obligation within the next 24 months, and every single one of the entries on the above list would constitute doing exactly that (and/or worse). The best predictor of future credit performance is past credit performance, so the fact that you allowed yourself to do anything on the “greater than 90” list above means, statistically, that you’re more likely to do it again.
Myth: Credit scoring models consider information not on your credit reports
This is one of the most common myths bouncing its way around the blogosphere as it pertains to credit scoring. There is widespread belief that information that does not appear in credit reports can be influential to your credit scores. This is simply untrue, and here’s why:
One complete technical name for a generic credit score is “credit bureau-based risk scoring system.” The term is seldom used because it’s such a mouthful, but the key phrase in that formal title is “credit bureau-based.”
Because credit scores are bureau-based, they limit their consideration to information that actually appears on credit reports and is, more specifically, currently appearing on your credit reports. Credit cards, student loans, bankruptcies, balances, and inquiries are all things that can and do appear on credit reports and are considered by credit scoring systems. There is, however, a list of items that might seem logically influential on your credit scores but are not because they do not appear on your credit reports.
How long you’ve been employed, your income; how much money is in your savings, 401k or other retirement accounts; your level of education, your profession; the value of your home…none of these count in your credit scores because they do not appear on your credit reports. (Exception that proves the rule: Your profession sometimes appears on your credit report, but scoring models ignore that entry.) Lenders can and do take many of these factors into consideration when deciding to issue loans, but they typically require you to document them yourself, since they cannot obtain them through your credit report, and they are not reflected in your credit score.
And finally, if you’ve filed bankruptcy, missed payments, taken out a new loan or done other things that ordinarily appear on credit reports but these items just happen to be missing from yours, then they will have no influence on your credit scores until they eventually appear on your credit reports.