A Practical Discussion of Credit Bureaus and Their Scores

 By: Linda Kester
Usually I spend my time talking, writing and teaching about sales related issues. Typically they center around topics such as motivation, sales techniques, goal setting, etc. Very often though, when I get to the question and answer part of my presentations, I am asked questions about credit. This is a topic that is near and dear to every sales person but because it is usually out of his or her control, it is not discussed as a part of most sales training courses. Even when it is, the training usually consists of selling the decline while trying to get the next deal from the vendor or broker. Because understanding credit issues is essential to success in this business I decided to do some research and write an article about an area of credit that is used frequently, especially in small ticket leasing, but is often misunderstood - the principal's personal credit bureau and associated scores.

Why is the principal's personal credit report so widely used in our business? Actually there are many reasons. They are inexpensive, usually two to four dollars per report depending on your volume. The information is rich - many consumer credit issuers report their results to the credit bureaus. They are available to any credit issuers, so a new company can have access to the same information as established lessors. The primary reason, though, is that they are predictive. For a variety of reasons the consumer credit report of the owner/partners/officer(s) of a business is one of the most reliable sources used to determine the likelihood that the lessor will have a positive experience with the lessee.

As I prepared for this article, one fact became clear to me - much of the information reviewed on the consumer credit bureau as well as the associated scores is commonly misunderstood and used incorrectly. Not only can this cause your company to decline an acceptable credit or approve someone with a high probability of defaulting but it can cause you to lose a vendor who gets his deals approved elsewhere or sever a relationship with a vendor who has too many defaults. I have found that some information that is commonly relied on is often incorrect. The scores are often misinterpreted or relied on too heavily. People also often override scores with information that is not only factored into the score but the people who developed the scores found that particular information not to be very predictive of the likely results. As the person responsible for the relationship, it is your job to make sure you know when to challenge the unwarranted decline and when to move onto the next deal when this one stinks.

What Do These Scores Mean?

There are three main consumer credit bureaus; Experian, Trans Union and Equifax. Each of those has many scores associated with them used for a wide variety of products. The two that are most commonly used in our business are the Fair Isaac (FICO) score and the bankruptcy score, with the FICO score the more prevalent of the two. For purposes of this article I will focus on the FICO score as that is more widely used and, consequently, more often misunderstood. The FICO score has different names for each bureau. For Experian it is called the Experian/Fair Isaac risk model (these people are known for their math, not their creativity), for Trans Union it is the Empirica, for Equifax the Beacon. Even though they are different models built for different bureaus they are designed so that the scores predict the same results. In other words, if the same issuers, etc. report to the same bureaus, a 660 Empirica score should predict the same result as a 660 Beacon score.

The FICO score predicts the probability that that consumer will have accounts that are 91 days delinquent or worse (including chargeoff or bankruptcy) within the next 24 months given the information reported on his or her credit report at that time. That fact is important to understand. It does not take into account the fact that the company just lost their best customer who accounted for 80% of the company's revenues or that their biggest competitor down the street just got indicted for price fixing. It doesn't take into account anything about the business. Not how long they have been in business, how high their sales are or even if all of their customers are suing them. It is conceivable (and not that improbable) that a company can be in bankruptcy and the principal can have a perfectly acceptable FICO score. It turns out, though, that because the information on the bureaus is extensive and the scores are very reliable for their designated purpose that they also happen to do a very good job of indicating the likelihood of poor payment performance of small ticket lessees. Translated - the owner of a business who has a score indicating a higher probability that he will pay his personal bills late also has a higher probability of defaulting on his company's obligations. They will not have the same probability though. It's just that someone with a low score has a higher probability of default than someone with a higher score.

The people at Fair Isaac use many factors obtained from the credit bureaus in determining their scores. For the Empirica model, for example, there are 30 active factors available for the model to use. When you obtain a score from one of the credit bureaus you should see the four factors that, for that person, had the most negative influence on the score. Even people with good scores will have a list of the most negative factors. They will be in order starting with the most negative. This is important to know. Next time you look at a score and you ask yourself: How did that guy score so low? Just look at the factors and you will have your reason. You may not always agree with it but you will have your explanation. Often you will see two different bureaus for the same individual and they will have large differences in their score. First, use the factors displayed to determine why the gap in scores. Then use the score of the bureau that had more relevant information. For example, if the lower score had as its first factor listed Serious delinquency and the higher one didn't, see if the serious delinquency was only reported on the one bureau. If that is the case and the other information seems similar, use the lower score in your decision making process.

As I mentioned above, the credit bureau scores will not tell you the probability that your lessee will default on their lease. They do tend to rank order small ticket leasing customers in terms of probability of default if other factors are equal. That means that if other factors are similar, a customer who scores a 620 should have a higher probability of default than someone who scores a 630. It does not mean that someone starting up a restaurant and has a bureau score of 660 has a lower probability of default than a doctor who has owned a medical practice for 15 years and has a bureau score of 650.
Once you accept the fact that the scores do a good job of rank ordering your customers (you should verify this independently) you can take advantage of the value of the scores. If the scores work and you use them properly you should be able to increase your approval rates, lower your loss rates or a combination of both. Other benefits of relying on scores are as follows: More objective decision making, faster decisions, measuring application quality from your sources, forecasting loss rates and risk adjusted pricing.

Credit scores, particularly those not designed for your business, do have weaknesses. The Fair Isaac bureau scores weren't designed to predict business failures and certainly not leasing defaults although they happen to be a valuable tool for both in our line of business. They were designed for consumer information and results only. You have to determine how much weight to apply to things like years in business, type of business, collateral, etc.

They also don't predict capacity. Just because a small business owner has a very good score doesn't mean the business can handle a $500,000 lease. At that level you are probably better off learning what the lease is for and what is the source of repayment than relying on the bureau score alone. Bureau scores also do not prevent fraud. You can get in trouble if you rely on them too heavily and do not keep the same fraud prevention techniques you had before.

There are two areas where, in my opinion, the bureau scores do not do a good a job as they do in other areas. First is when the company is larger. The larger the company the less its behavior mirrors that of its principal and, therefore, the less predictive the score. The other area is when the principal of the business is wealthy. A lot of small business owners are wealthy, some very wealthy. Wealthy people often behave differently in many areas, including how they handle their personal finances. For example, if a wealthy person has some slow payment patterns on his credit bureau it could be that he just never got around to it or even that his personal assistant who pays all his bills was on vacation for a week, not that he was short on cash that week. They also tend to have different types of revolving lines and often more inquiries than the typical person for which the bureau scores were designed.

After the score, what else do I look at?

Even if you have the score, there are other parts of the consumer credit bureau that provide information that can be valuable but also misunderstood or used incorrectly. One of the first things you will see on a credit bureau is the consumer identifying information. This are will typically include information such as name, address, previous address, social security number, employer as well as some other personal information. Be careful when using this information. Much of it is often updated by both trade tapes and inquiries and therefore is not always accurate.

The fraud alert section of the bureau is one that you should pay attention to especially since the scores you are using are not designed to prevent fraud. The alerts vary both in terms of occurrences and severity. You have to make your own determination as to how heavily to weigh them primarily because different lessors have different sources of business and different protections against fraud, both contractual and otherwise. Typically, I suggest paying more attention to alerts that have something to do with the social security number.

The summary section is a bureau option that many subscribers prefer. It is an easy way to grasp much of the bureau quickly. I would caution against this, though. If you want a quick and easy way to evaluate the bureau, rely on the score. If you want to understand the customer more completely, look at the trade lines. One of the areas in the summary that is particularly misleading is the revolving availability percentage. This is the percent of line not utilized on revolving credit (typically credit cards). Credit card issuers are inconsistent in how they report credit lines. Some report the line available, some report only the highest amount ever used and some report no lines at all, only usage. If someone has a $20,000 line and $5,000 currently out on that line but the amount of the line is not reported it will appear in the summary that he has 0% availability when actually he has 75% availability. Another area in the summary than can be misleading is the real estate balance. As you probably know, mortgage holders frequently sell the mortgage to other issuers. If the first mortgage holder does not properly report the mortgage as sold or closed, it could appear as if the customer has twice the real estate balance that he actually has. If you read the trade lines and saw two mortgages for the same amount you would at least suspect the possibility that they were for the same property, especially if one did not show any recent payment history. Read the trade lines!

The public records section of a report is one area that always gives people trouble. They are scary looking, especially suits and judgments. There are a couple of things you should know as you look at this section. They are factored in the score. They are less than 100% accurate, especially releases and settlements. Anyone in our business more than a month has had a situation where you told someone about a suit on their credit report and was told That was released years ago! They also may not be as predictive as you might think, especially for larger businesses and wealthy principals. Suits are part of their lives because they have various complex business dealings and they happen to have deeper pockets. Again, as in fraud issues, you have to make your own determination about severity, how recent and the other data you have on the applicant.

The trade lines are the meat and potatoes of the credit bureau. It is where most of the information is derived to form the score and it is the details outlined in the summary. One area that is important to understand, especially as you look at accounts with a delinquent history, is the timing of the delinquency. The trade lines will tell you this. Usually, the payment history, which shows the frequency and severity of delinquent payments, will show the payment history backwards from the balance date shown on the report. This is important to know as the recency of delinquent payments is vital to your decision making process.

Another factor to look at when reviewing the trade lines is the amount and type of revolving credit. Credit departments often look at high revolving debt and utilization rates negatively and justifiably so, but there are exceptions. One example would be two people that have $100,000 in revolving lines and $90,000 in revolving debt. Notwithstanding the possible errors I mentioned earlier in the article, they would both have 10% availability on their revolving credit and both frowned upon by your credit staff. What if one guy had 10 credit cards each almost max'd out and the other had a $100,000 bank line with $90,000 out on it. I would argue that the second guy was a much better risk for a variety of reasons. He probably has a legitimate business reason for the loan, is paying a much lower rate and undoubtedly the bank did a more thorough due diligince process than any of the other guys credit card issuer. The trade line section is the area where you can get more details on your customer to do more thorough analysis.

Inquiries are a part of the credit bureau that can create problems, particularly for a broker as well as for a funding source that does broker business. In theory, inquiries are factored into the score and should be left at that. In our business, however, there is much more to it than that. The funding source is concerned about things like whether the deal was shopped, or worse, cleansed. They are also worried about whether the deal is being split and/or how much leasing the customer is getting right now. From the broker's point of view if someone declines the deal they should send it somewhere else. That is one of the advantages to being a broker. Also, often they are the leasing source for a lessee that does a lot of leasing and they send the deals to different companies depending on their appetite, deal structure, rates, etc. and they are often penalized because other companies are less than straight forward with their information. Absolutely none of that is factored into the score and should be evaluated according to your own company policies.

As I mentioned at the beginning of the article, I often get asked questions about credit even though I am usually in front of sales and marketing people. Often the questions are about personal credit reports that are frequently used and too often misunderstood. All of this shows that credit is important for sales personnel to understand. Even if you don't have the ability to overturn a decline, you need to explain the decisions to your vendor or broker and give them the confidence to know that you are capable of handling their next transaction. In this article I have only touched on some of the issues with credit, credit bureaus and their scores. If you are interested in learning more about how to read credit bureaus, I suggest contacting the bureaus and asking for their literature. I have found it readily attainable, informative and easy to follow.

As I touched on only some of the credit related issues that I believe are important to sales professionals in our industry, I would like to welcome questions or comments. Please e-mail me with your comments or questions and I will respond quickly.
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