Credit: the system and you.

Credit impacts almost every aspect of our financial life. Of all the things in our life, we seem to know the least about credit, yet understanding it is extremely important. We’ve gathered what we think you should know on this page.

Our unbiased perspective of credit.

There are hundreds of articles out there on credit. Why should you read this one?

We are uniquely positioned to tell you things in an unbiased manner. Because we are an independent third-party escrow company that sits between service providers and consumers, we have a unique perspective. We don’t have a horse in the race and we can call it as we see it. 

Defining and understanding credit.

Anyone can go to Google or some trusted financial website to find a definition of the word “credit.” Here’s what that might look like.

credit definition

It might be more helpful to try to understand credit, rather than accepting some potentially unrelatable definition.

Here’s an example. I vividly remember a story about credit in an international business book I read in college. It showed two people at a dinner table ordering food and the book explained that that, right there, was credit. How?

A person, the waiter or waitress, walked up to another person, and provided a service, uncompensated. The cooks began to take the order and eventually the food showed up at the table, uncompensated. The patrons received the goods and services based on their promise to pay.

Come to think of it, that reminds me of J. Wellington Wimpy’s famous line: 

“I’ll gladly pay you Tuesday for a hamburger today”

That is the fundamental concept of credit ; a transaction that occurs using the promise of repayment as currency. 

If credit is so easy, then why is it so complicated?

Credit is everywhere; from a promise to pay back your friend, to utilities, to leasing or buying cars or properties, to opening credit cards, bank accounts, loans, to job applications. 

Furthermore, every player in the game has a different opinion of how credit should work and they have different objectives when handling credit. The banks view and handle credit differently than the government, which handles everything differently than you would as a consumer. 

With that much entanglement in our lives, credit has become subject to rules, laws, regulations, and policies. And, because credit is everywhere, there’s a lot of areas where things can go wrong.

Credit is a mess. Here’s why…

Imperfections exist in almost every aspect of our lives. Most imperfections we overlook because they don’t have much of an impact. In the case of credit, it’s much more difficult to overlook problems.

The credit industry is massive, complex, ever-changing, and incredibly susceptible to problems. 

When credit problems show up in our lives, we see them as an event that just occurred. However, the thing that just showed up in our life was years, if not decades, in the making.

Substantial harm can come to consumers in the market of credit. It is natural for people to conclude this is so because “people are bad.” For some people, they imagine that the issues stem from the big evil banks. For others, the issues stem from consumers that don’t pay bills or commit fraud.

That assumption has merit. There are indeed people out there who misuse credit.

However, the larger problem with the industry – no pun intended – is how large the industry is. Regulating such a large industry leaves a lot of room for gaps in monitoring and understanding. Couple that with the ever changing regulations and it’s easy to see where things can go awry. 

Here’s an overview of the different players in the credit industry, showing how those in the credit world interact with each other.

Consumers

It’s not entirely crazy to suggest that the entire credit system starts with you, the consumer. An individual’s payment behavior, especially repayment behavior, really dictates their credit worthiness. 

The biggest mistakes made by consumers is not inputting the correct information on applications for loans or credit cards. These mistakes, usually missed by lenders, cause many issues down the road.

Lenders track payments and send that information to the credit bureaus. We will discuss that more below. 

The point is, everyone’s credit worthiness combined dictates the credit industry. That is a reduced version. However, that is what all other aspects of the industry stem from.

The punch line, if you will, is this:

The key is a consumer’s repayment behavior. The problem is whether information is recorded and whether the information is recorded accurately.

Let’s take a look at the next player in line – the Big Banks.

Big Banks

As you know, consumers usually go to Big Banks to get loans and create accounts. Banks fund the loan and expect repayment.

As the consumer pays, or doesn’t pay, banks record this information and update the accounts of the loans. The banks send the information to the credit bureaus.

Or at least, it should be. 

The banks do not always send the correct information to the credit bureaus. This is one of many areas that can be problematic for many consumers. A consumer can call their bank and request that erroneous information to be corrected.

This is a direct creditor dispute.

Even thought it is annoying, it is easier to solve problems at first. However, issues that take place at a higher level tend to be more difficult to address and more frustrating.

The Credit Bureaus

Probably the biggest player in the game is the credit bureaus – TransUnion, Equifax, and Experian. I don’t mean to say that they are the most important, but rather that this is the player that tends to cause a lot of issues for consumers. 

First and foremost, the credit bureaus do not collect credit information from the consumer directly. The Big Banks report the information to the Bureaus, and the Bureaus update the credit reports. Incorrect information sent to the credit bureaus ends up on credit reports.

The bureaus have a heavy burden.

While the Bureaus are responsible for maintaining accurate information, they are monitoring the reports for *literally* hundreds of millions of people.

Because they have so many people to monitor, mistakes often go undetected, until the consumer brings up an issue through the dispute system, which we will talk about more below. 

Accuracy is consequential.

If an issue made at any level remains uncorrected, then it will get propagated through all levels of the credit system.

Other companies use information in the credit reports. For example, credit modelers use the information held by the bureaus to create credit scores.

Credit score modelers

Each consumer has multiple credit scores. There are different credit scores. Every scoring model varies, so there are different credit scores for each bureau as well. Yes – the amount of credit scores is overwhelming and complicated, but we haven’t even scratched the surface, yet.

The main problem with the credit score modelers is that they accept and factor data in credit reports whether it’s flawed or not. The “garbage in, garbage out” concept applies, perfectly.

The second problem with credit score modelers is that it’s an inherently imperfect system.

  • The system is constantly changing, making it incredibly difficult for the consumer to navigate through addressing any issues.
  • The models also change frequently, so your credit score may change even if nothing on your credit report did, leaving consumers baffled.

Finally, the credit scores do not take into account extremely relevant factors, such as your employment status.

  • Someone employed and has a consistent income is more likely to repay a loan and should have a higher credit score. However, that is not always the case.
  • Since important information is not factored into the reports, it is easy to see that the credit scores aren’t a perfect depiction one’s creditworthiness.

Credit Repair Companies

Yes, the credit system is inherently problematic. Yet, consumers are not always without fault for their low credit scores. Some people have poor credit because they were unable or unwilling to repay their loans.

For people in this situation, there is still hope! That hope comes in the form of credit repair

There are many aspects to credit repair. The first (and most well known) is the removal of incorrect information from a credit report. Complication arise in credit. The same is true of credit repair. Even so, there are professionals who know the system who are able to work on a consumers behalf, to help improve their credit.

For any negative item that can be found on a credit report, there are multiple businesses that can address the issue. Companies comply with law. Laws make credit repair more complicated.

The Government

As with most industries in our country, the government plays a huge role in regulating the practices of the credit industry. Let’s start with the most fundamental aspect of the credit system:

Personal identification numbers.

  • Social Security Numbers (SSNs): Every individual’s unique identification number. Without Social Security Numbers, the credit system as we know it would not exist. Why is this? Credit and social security numbers link. This is the way that the credit bureaus are able to differentiate between you and everyone else in the country! 
  • Employer Identification Numbers (EINs): the identification numbers for businesses. Businesses do have credit scores. There is a separate system for determining business credit unassociated with your social security numbers. 
  • Taxpayer Identification Numbers (TINs): Another form of identification used by the IRS in the administration of tax laws. TINs are different from the SSNs. The credit system disregards TINs.

False identities.

There are many more types of identification numbers, but these are the most common. Because there are so many different numbers, people have started to create a new identification number that is said to help you improve your credit score if you have a low score – that is a Credit Privacy Number (CPN).

CPNs are marketed as replacement SSNs. The general idea is:

  • The credit score associated with your SSN isn’t good enough.
  • You can get a “new” number.
  • You “replace” your SSN with a new number.

However, that isn’t the way it works. 

In fact, this is a scam and CPNs are illegal. The CPN is an SSN. CPNs are obtained through untrustworthy means. Image stealing an SSN from children, senior citizens, or prison inmates. CPNs create a false identity for you. CPNs are incredibly harmful for the individual whose identity was stolen.

The government provides identification numbers so that each individual person or business can file taxes, etc., without confusion between individuals. But this isn’t where government involvement ends, it is really just the beginning.

Government Regulation

Ironically, credit-related businesses and consumers alike both turn to the government for protection.

The consumers want “Consumer Protection Laws” that protect them from the big credit businesses, and the businesses want to be protected from the legal actions of consumers.

To address these concerns, the government created some laws that regulate the operations of the businesses and the actions that a consumer can take.

Fair Credit Report Act (FCRA)

The FCRA ensures information reported to the bureaus is accurate. Also, the FCRA limits the amount of people who have access to that information. 

Because the FCRA dictates how information is reported to the bureaus, it also provides a way for incorrect information to be corrected. The Act also provides that the bureaus must have access to a dispute process to address mistakes. Furthermore, the FCRA protects the bureaus from lawsuits. How? The FCRA requires a dispute be filled before legal action can be taken.

I’m not going to go on a conspiratorial rant, here, but… ask yourself: Are my “rights” to sue a credit bureau under the Fair Credit Reporting Act actually procedural hurdles that make suing more difficult?

While the vast majority of consumers won’t even consider filing a lawsuit, there are a few that feel that this is the only way they can resolve issues they’ve found on their reports.

However, I tend to believe consumers are probably better off in the imperfect dispute system because it’s a very inexpensive lawsuit / arbitration-like procedure that can actually benefit consumers. The downside is that it’s relatively complicated, resulting in the need for assistance. 

Fair Debt Collection Practices Act (FDCPA)

For anyone who has gone through debt collection, it may be aggressive and abusive. This Act establishes legal protecting to protect consumers from abusive, deceptive, or otherwise unfair collection practices.

Credit Repair Organization Act (CROA)

This act regulates how credit repair organizations can interact with their consumers by requiring disclosures for companies offering the sale of “Credit repair” services.

Most prominently, this act prohibits companies from demanding advanced payment for services not yet received. It also requires contracts to be in writing for greater accountability and gives consumers a three day cancellation period after signing the contract for credit services.

The Federal Trade Commission Act (FTCA)

The FTCA creates an independent agency that focuses on enforcing antitrust laws and consumer protection. This agency inhibits credit repair agencies from charging for services until after the services have been distributed.

While this may seem like a good idea, it makes it incredibly difficult for good credit repair companies to function, pushing out the good companies and leaving room for the bad ones.

Additionally, increased credit regulations creates increased operating costs. Increased operating costs create increased fees for consumers. Because credit repair companies have to jump through so many hoops to provide services, their rates are continuing to increase rapidly.

Consumer Financial Protection Bureau

The CFPB is one of the many agencies that Congress has delegated authority to regulate the credit industry. The CFPB is effectively an extension of the FTC. The CFPB helps regulate organizations regulated by the FTC. It creates additional rules and regulations that must be followed.

Telemarketing Sales Rule (TSR)

This rule applies to all companies that use telemarketing, with few exceptions. With respect to credit, it heavily regulated credit repair companies. This rule dictates that:

  • a credit repair company that uses telemarketing can’t take money for 6 months after services are performed.
  • After 6 months, the company needs proof that services have been completed in order to collect payment.

This is almost impossible for credit repair companies. It is completely impossible for tradeline companies (where service last only 45 days or so).

While the government does create a lot of legislation, they do provide some assistance for those struggling with their credit.

Government sponsored credit counseling: 

Did you know that the government helps with credit counseling? Through designating companies to be nonprofits under 501(c)3, credit counseling services have started emerging, and they are here to help anyone with their credit.

More specifically, credit counseling is a service that was created by banks to walk people through how to pay back their loans, rather than declaring bankruptcy. This sounds great, but why did the banks do it?

Banks wanted to keep their consumers around to repay their loans, even though declaring bankruptcy would have been better for the consumer. This is obviously good for the bank, but many consumers have suffered from the misguided directions of these services.

Those are the key players of the credit industry. From the consumer providing incorrect information to the banks to the legislature that regulates the credit industry, there is a lot of room for error in the system. But don’t get discouraged because the story doesn’t end there.

There are major benefits to our credit system.

While there are drawbacks with any system, there are definitely some benefits from our credit system. 

  • Instant decisions: The first benefit is that decisions can be made instantly. With most banks, you can go on their website and apply for a new credit card. You can be approved within seconds. Because the banks have access to your information and the bureaus are consistently updating their information, your creditworthiness can be determined on the spot.
  • Focus on consumer protection: The credit industry has certainly had its fair share of blunders, but these blunders have served a purpose. For every major problem that has occured, someone has stepped in to provide a solution.

    There are many legislatures in place to protect both the consumers and the providers in the credit industry (FDCPA, FCRA, CROA, FTC to name a few).
  • Anti fraud protections: The Bank Secrecy Act (BSA): Also known as the Anti-Money Laundering (AML) law was set in place to combat money laundering, thus protecting consumers from financial institutions.
    The BSA requires financial institutions to partner with government agencies to help consumers and the country. It also requires that financial institutions must keep records of cash purchases and file them. Any suspicious activity must be reported.
    To comply with this law, financial institutions develop AMI policies, which are internal policies that outline how they fight against money laundering, specifically. This document provides a good defense for companies whenever their practices are called into question. 
  • Credit freezes: This feature allows consumers to regulate the access that potential creditors have to their reports. This is beneficial because it stops other fraudsters from opening credit cards or loans in your name.

    But your credit doesn’t have to stay frozen all the time. If you need to apply for new credit, you can unfreeze your credit so that creditors can view your reports. Once you’ve achieved your financial goals, you can lock your reports so that no one else can apply for credit in your name.
  • Fraud alerts can be placed on your credit reports to notify lenders and creditors to take extra steps to verify your identity before issuing credit. This is a common occurrence for anyone who has been a victim of fraud and it provides an extra level of security for consumers. 


Ultimately.

Ultimately, we should be grateful for the protection we receive in the credit industry, but we should also be prepared to deal with problems if we need to address issues with our reports.

The credit industry is big, bloated, and it will likely cause some problems in your life. You, as a consumer, likely don’t have time to read consumer protection laws or have the funds to sue billion dollar corporations like the credit bureaus. 

That said, as messed up as the system is, it works. We as consumers still receive the benefit from it. We must be prepared to deal with the inevitable problems and have perspective to realize that we have a good, though imperfect, system.