Other Risks
Small Stuff That Ruins Your Credit
By Daniel Muniz
The greatest leverage a creditor has is the
ability to report your credit behavior to the credit bureaus.
Responsible credit behavior results in positive reporting while
skipping a payment or not paying your creditors at all taints your
credit score. And that is just the creditor; a collection agency can
wreck havoc with your credit. Late payments are bad enough but the
damage from collection activity of a bill collector can ruin your
credit for years to come.
Unfortunately, creditors are not the only organizations that
employ the services of collection agencies.
A bill collector doesn’t have to represent only a credit card
company or a bank; they can be hired by just about anyone. For
years, big utility companies like the phone and cable company to
other types of businesses like a fitness club have used collection
agencies to get payment of unpaid bills. But in today’s environment,
more governmental entities are starting to use bill collectors such
as your local library. In fact, the use of collection agencies by
local and state agencies has exploded.
What confuses and frustrates people is the
perception that only a creditor or a large corporation can use a
bill collector to wreck your credit. It feels a bit too far-fetched
to believe that a library fee or an unpaid traffic ticket can
demolish your credit rating but it can and does happen.
On a side note, even the private university I attended used a
collection agency to collect a small unpaid balance from me. Talk
about Alumni relations after I graduated. When I got their
solicitation for donating money to the school, using their reply
envelope I promptly inserted my own expletive-laced response that I
cannot print here explaining what I really thought of their
educational institution. Somehow, I don’t think that the alumni
office ever forwarded that letter to the priests and brothers
running that small Catholic college.
But why should your credit languish because of
an overdue library fee or speeding ticket?
After all, isn’t your credit score supposed to
represent a predictive value on your ability to pay future debts?
Collection activity for one-time events is not indicative of your
credit worthiness. Just ask anybody who has experienced a
catastrophic injury or illness. Such unfortunate events do not
necessarily reflect the credit worthiness or character of an
individual although they will devastate your credit score.
Amazingly, even the Fair Isaac Corporation,
the organization that calculates the FICO credit score for the big
three credit bureaus agrees!
In fact, Fair Isaac would love to perform
research on the medical collections to determine if they really do
have a predictive value but they are unable to do so since the
credit bureaus do not differentiate between categories of collection
activity. All collection activity gathered is treated as the same
negative type of information without being categorized.
The Fair Isaac Corporation does not gather the
data; it only interprets it to generate the credit score. It is the
credit bureaus that compile the information but they are under no
pressure to delineate such data since credit reporting is purely a
voluntary function. As a result, the FICO score cannot tell the
difference between collection activity stemming from your car
getting repossessed to an unpaid traffic ticket.
But these questions lead to a bigger question.
If such activity like an unpaid library fine or a catastrophic
illnesses does not truly represent your future ability to pay a
debt, then why gather such information in the first place especially
since it can trash your credit for seven long years.
Ah, that is pearl of all questions.
Seven years is a long time and although the
Fair Isaac Corporation insists that your credit improves over time
when you exercise good credit behavior, the very existence of a
negative item can be held against you for seven years. And Fair
Isaac also asserts that a credit score does not determine your
credit approval. Both positions are true but the consequences of the
credit items remaining on your credit profile for up to seven years
can still reach out and hurt you even if they are irrelevant and
dated.
So, why do the credit bureaus lump predicative
and non-predictive data into the same category?
The answer is simple. Although the credit
bureaus and the Fair Isaac Corporation deny this, a credit report
and its corresponding credit score has increasing become a sucker
list. The credit report and its score have become more of a
profitability forecast than a credit worthiness projection.
Creditors can charge you more for credit even
if certain negative credit items do not accurately predict your
ability to pay future debts. Across the board, consumers lose.
Are there ways to fix this?
The easiest fix would be to ban municipalities
and government agencies from using third party bill collectors or
allowing them to report to the credit bureaus. However, I personally
feel uneasy about going to such an extreme. The remedy ought to be
for finding deadbeats as opposed to punishing someone with an
overdue library fee or an unpaid parking ticket. A deadbeat is just
not in the same category.
Municipalities and governmental agencies ought
to have a way to locate and squeeze deadbeats so I don’t mind them
using bill-collecting pests to track them down and ruin their credit
ratings.
Everyone else who is willing to pay ought to
be able avoid having their credit trashed. Perhaps a better approach
would be the path of defaulted student loans. The government waves a
carrot to the delinquent student loan holders by promising to remove
all negative credit items once a student loan is taken care of.
This approach allows a government entity the
ability to punish you until you pay up and then permitting you to
walk away with a clean slate once the delinquent account is paid in
full. This process will separate the deadbeats from the people who
forgot to pay off their traffic fine.
Another approach is to simply identify or
categorize the source of the collection. Categorizing would allow
Fair Isaac to finally play fair when generating credit scores. And
it also prevents the credit bureaus from exploiting the people with
medical hardships. Lenders, provided that they use a live human
being for making decisions, can more easily differentiate between a
collection that involved actual extended credit to something that
irrelevant like an unpaid book fine.
But until this process gets cleaned up, you
best bet is to be vigilant in not getting your name put the sucker
lists of credit reports.
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