(Editor’s note: I am not a financial advisor. Any information presented in this article should not be taken as financial advice. Always consult with a financial advisor on decisions regarding your finances.)
Back in the early 2000s, interest rates were incredibly low after the dot-com crash which was spurred on by excessive [investor] speculation in the tech industry causing a recession. Prior to the crash, the Federal National Mortgage Association also known as Fannie Mae was leading the charge to make homeownership more accessible to people with low credit scores. This would come to fruition in the aftermath of the dot-com crash as the the Federal Reserve dropped interest rates to a historic low — going from 6.5% to just 1%.
This unintentionally created speculation in the housing market with more and more homes being sold to buyers who shouldn’t have qualified. Those with bad credit and no savings were being approved with unconventional terms on mortgage loans which were in turn repackaged and sold to investors on the secondary market.
And well, we all know how the story ends. UltraFICO would be nowhere near on that scale, but there’s some speculation it could prove to be a terrible idea since in principle — it definitely sounds like what led up to the housing bubble crash.
I remember walking into Bank of America several years ago and being encouraged to apply for a credit card. I already had one, but the credit line was abysmal.
I applied for it and was promptly denied.
It left me with both a pretty bruised ego and a hard inquiry on my report.
Ignorance is bliss, and I had no shortage of it growing up. And I only have myself to blame for not taking action sooner. There are people out there who have not invested time into building their credit and FICOs new model might sink them further. My upbringing wasn’t the worst, but it was challenging since so many things happened that were hidden from me. Finances weren’t any different. My family never discussed credit scores. Hardly anything relating to finances was ever discussed unless it was my brother and I getting berated for leaving a light on in a room we weren’t currently in.
We were told we were not adults and weren’t paying the bills every month and it was accompanied by a dollar amount for the previous month’s light bill. It never occured to me to ask questions despite my curiosity about the world in general. I wanted to know the significance of money and why my parents and grandparents struggled and never seemed to have a lot. As I grew older, I understood why: they were all financially illiterate, and so was I.
So inevitably, I would go on to have the same bad financial habits, including using a good chunk of my credit whenever possible. Student loans were also killing my score, and I was drowning in debt at one point stemming from creditors coming after me.
A week after being denied for Bank of America’s credit card I received a letter in the mail which broke down my credit score. I was at 440.
I knew all about credit scores, but I underestimated how valuable it would be for me in the future, and never cared to pay attention to it, but I started learning in 2014. Little-by-little, day-by-day, I became obsessed with my credit score.
In retrospect, I did understand Bank of America’s decision. I just wasn’t responsible enough.
Your credit score explained
There’s plenty of articles detailing what credit scores actually are. Whether you’re a young teenager starting out or perhaps you’ve been uniformed or misinformed and aren’t up to speed — check out this article here to understand your FICO scores and what they are.
But for simplicity sake, your credit score works like this: you’re assigned a number based on several factors which include (from most important to least important)
Payment history (35%)
Credit utilization (30%)
Length of credit history (15%)
New credit (10%)
Credit mix (10%)
Either your FICO or VantageScore can be used to assign a number ranging from 300–800.
Those percentages are estimates for FICO score calculations, because FICO does not release any precise information about their modeling.
The three credit bureaus, Experian, Equifax and TransUnion, aggregate this data monthly, and each of them draw their own conclusions to assign you a score which is why your three scores are always different.
The higher your score is; the better interest rates you'll receive from banks.
Although it sounds like a superhero who’s just powered up for the 4th time in 10 episodes, it’s a very real model that should help consumers who are just starting out and can also already help those with bad credit — in theory, at least.
David Shellenberger, senior director of scores and predictive analytics at FICO said it tends to benefit two groups of consumers:
Those with “thin” files, or little credit history.
People trying to rebuild credit.
However, there is a concern with this idea, because — just like what we witnessed with the 2008 house market crash — not everyone should be approved for lines of credits and/or loans.
That’s why lenders start off with low amounts and high interest rates, or banks offer secured cards.
Adding as much as 20 points to someone with a savings account and a thin file can possibly set them up for failure if they prove to be financially unstable later down the line.
If the practice does become widespread and adopted as a standard for some banks — borrowers could still see high interest rates which would needlessly compound their debts. After all, credit does involve varying degrees of being in debt to a company. Even if you do pay off your credit cards on time every month; it doesn’t change the fact you’re borrowing that money. Sometimes there’s emergencies and job losses, and while we won’t see a lot of lending due to COVID-19’s impact on our economy — it’s still worth noting this can potentially open up a pandora’s box for more financial woes for US citizens who aren’t careful enough.
And while UltraFICO is still in it’s piloting stage, there’s still some reason to be concerned that banks can take advantage of variables not known at this time — including the use of predatory tactics to attract new customers.
There’s also security concerns, because you’d have to give FICO access to your bank statements.
At any rate, I wouldn’t take the bait. The lesson here is to learn more and understand your credit score and what affects it and how you can improve it with the correct spending habits; a boost for a loan you’re not qualified for at banks could spell disaster for anyone not financially ready yet as we saw with the housing market crash.