ECONOMICS: Credit Scores do not accurately measure someone's financial abilities

Have you ever been denied a loan or an apartment rental because of your credit score? Or maybe you've wondered why your score dropped even though you've been paying your bills on time? These questions touch on a debate that's been growing in recent years: Do credit scores really reflect our financial capabilities?

Welcome to your Dinner Table Debates Daily Deep Dive where we explore real topics from our decks and give you everything you need to debate, in under 10 minutes. Today's topic is "Credit Scores do not accurately measure someone's financial abilities" and comes from the Economics Category in our Full Size Essentials Collection deck. Let's Dig In.

Before we dive into the debate, let's understand what credit scores are and where they came from. Credit scores were introduced in the U.S. in the 1950s by the Fair Isaac Corporation, now known as FICO. The goal was to create a standardized way for lenders to assess the risk of lending money or extending credit to individuals.

Today, the most widely used credit scores in the U.S. range from 300 to 850. They're calculated using complex algorithms that consider factors like payment history, amounts owed, length of credit history, new credit, and types of credit used. The three major credit bureaus - Equifax, Experian, and TransUnion - each produce their own scores based on the information in your credit reports.

According to a 2021 survey by Credit Sesame, 55% of Americans have been denied credit due to their credit scores. Meanwhile, the Consumer Financial Protection Bureau reports that about 26 million Americans are "credit invisible," meaning they have no credit history with a nationwide consumer reporting agency and are more likely to be denied credit as compared to even those with a low credit score. 

It's crucial to discuss the value of credit scores because this impacts many aspects of our financial lives. These scores determine whether we get approved for loans or credit cards, what interest rates we're offered, and even affect our ability to rent an apartment or get certain jobs. As you go through life, your credit score becomes one of the most important numbers you know, and you quickly learn how to manipulate it—what actions will improve it and what might harm it.

As an example, during the housing crisis of 2008, many homeowners were weighing the difficult decision of whether or not to stop paying their mortgages, basically stopping paying a loan that was being tracked on their credit history. As you might remember, this is when the housing bubble burst and millions of homes lost the bulk of their value practically overnight. Many found themselves "underwater," meaning their homes were worth less than the amount they owed on their loans.

Walking away from a mortgage, also known as "strategic default," causes a significant drop in credit score, making it difficult to obtain future loans for cars, homes, or even credit cards. However, foreclosures can be wiped from your credit report in 3-7 years leading to approximately 4.4 million homes foreclosed on between 2007 and 2010, according to the Federal Reserve. Its interesting to wonder how many of those were strategic decisions by homeowners knowing that they would just need to rebuild their credit history in order to get out from under an asset that lost a lot of value. 

Now, let's debate!

Agree (Credit Scores do not accurately measure someone's financial abilities):

1. Credit scores don't consider income or assets. A person with a high income and substantial savings could have a low credit score if they rarely use credit, while someone living paycheck to paycheck might have a high score if they consistently make minimum payments on multiple credit cards. But of those two people which would you rather loan money to? 

2. Credit scores can be unfairly impacted by factors outside of your control. For example, there are data breaches all the time that expose the personal information of millions of people. That’s just one example of how easy it is to fall victim to identity theft and have your entire credit history collapse through no fault of your own.

3. Credit scores don't reflect the full picture of a person's financial behavior. They don't consider rent or utility payments unless they're reported to credit bureaus, which often only happens when accounts are severely delinquent. This can disadvantage renters and those who prefer to use cash or debit cards.

Disagree (Credit Scores do accurately measure someone's financial abilities):

1. Credit scores have been shown to be predictive of credit risk. A 2015 study by the Federal Reserve found that credit scores were highly predictive of future loan performance, even two years out from when the score was measured.

2. Credit scores provide an objective, standardized measure that reduces discrimination in lending. Before credit scores, loan officers often made subjective decisions that could be influenced by personal biases.

3. Credit scores encourage responsible financial behavior. The factors that go into a credit score, like paying bills on time and managing debt responsibly, are generally good financial practices.

Now, let's explore some rebuttals.

For the first "Agree" point about income and assets not being considered, a rebuttal might go: While it's true that credit scores don't directly factor in income or assets, these elements are often considered separately in lending decisions. Many lenders use a debt-to-income ratio alongside credit scores to get a more complete picture of an applicant's financial situation.

For the third “Disagree” point about Credit scores encouraging responsible financial behavior you could argue: Because credit scores require a person to obtain credit in order to have their financial behavior scored, this actually forces people into a system that requires acquiring debt. When in fact, the more responsible financial behavior to encourage would instead be to save up and pay for expensive assets in full thereby carrying no debt. 

To sum up, the debate over whether credit scores accurately measure financial abilities touches on issues of fairness, financial inclusion, and the challenges of quantifying complex human behaviors. There are valid points on both sides, highlighting the need for ongoing evaluation and potential reform of our credit scoring systems.

Some steps are being taken to address these concerns. For example, in 2019, Experian launched Experian Boost, which allows consumers to add positive payment history from utilities, phone bills, and streaming services to their credit files. Meanwhile, some fintech companies are developing alternative credit scoring models that consider a wider range of financial data. 

Want to dig into this topic even more? Well, When you’re playing Dinner Table Debates at home, you can have Agree set the stage and choose how to define the debate. This means they can outline the terms, context, and interpretation, creating a unique and dynamic conversation every time. Here are some ways that Agree could redefine the debate topic “Credit Scores do not accurately measure someone's financial abilities”

Credit scores are too limited to be trustworthy: Do credit scores truly reflect a person’s financial responsibility, or do they overlook important factors such as income stability, saving habits, or the ability to manage money wisely without borrowing? Should there be alternative methods for evaluating someone’s financial health that take a broader range of behaviors into account?

Credit scores are too rigid and don’t adapt quickly to changing circumstances: How do unexpected events like medical emergencies, job loss, or natural disasters unfairly affect credit scores? Should there be adjustments in the credit scoring system to accommodate people who have faced financial hardship through no fault of their own?

Credit scores are inherently unfair: Does the current credit scoring system disproportionately affect certain groups, such as young adults, immigrants, or low-income individuals, who may have limited credit histories? Could relying on credit scores alone perpetuate inequality and limit access to loans, housing, and employment opportunities?

Bonus conversation starter: If you were to reinvent the FICO Credit Score system, what changes would you make to ensure it provides a more accurate and fair measure of financial abilities? Would you include additional factors like savings rate, rent payments, or utility bills? How would you balance the need for risk assessment with the desire for a more inclusive system?

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