Subjective Tinkering of Credit Scores is Bad Policy

Recently I made a case against a new IRS policy to withdraw tax liens from the credit bureau files of delinquent taxpayers who eventually pay their overdue bills. This subjective tinkering with empirically developed credit scoring only ends up hurting consumers, particularly those who legislators are trying to protect. It happens more often than you might think:

• When a government shutdown looked likely in April, five House members signed House Resolution 215, encouraging creditors “to safeguard the credit scores of members of the Armed Forces and their immediate family in the event of a Government shutdown.”
• The US Department of Education routinely has records of defaulted student loans stripped from credit reports if borrowers go through a “rehabilitation” process.
• Members of the House tried last year to prevent medical collection records from remaining on consumer credit reports once the patients had finally paid their bills.

FICO research repeatedly shows that records of such credit activities are highly predictive of credit risk for years after the fact. That’s why Congress has long allowed these records to remain on credit reports for seven years. They play a crucial role in helping lenders to objectively and fairly decide who should get their best rates or less favorable rates, or declined altogether.

When lenders and FICO® Scores are prevented from seeing these negative records, lenders are likely to loan to borrowers who are riskier than they appear. As a result, many borrowers are extended more funds than they can safely handle and they default again. Instead of learning better credit habits and improving their credit standing over time, these people have added new damage to their credit standing that will prolong their recovery to credit health.

Naturally many lenders are aware of this problem. When lenders can’t trust credit reports and credit scores, they have a harder time assessing credit risk.  Risk-based pricing becomes less feasible. To protect their businesses, lenders must spread more of their lending risk across all borrowers, resulting in millions of new borrowers paying higher interest rates.

That’s why efforts to protect the credit scores of select groups can have serious unintended consequences that can end up hurting all consumers. It’s why attempts to subjectively modify credit scores and credit reports is bad policy.