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Written by Jeff Keltner, SVP Business Development
A person’s credit score, a three-digit number, tends to play a significant role in qualifying for consumer loans and other credit products. A credit score is supposed to represent a consumer's “creditworthiness,” or how risky they are for a lender, however, it doesn’t provide an accurate picture.
The purpose of credit scores
Credit scores generally serve two purposes:
- They help lenders underwrite risk. A borrower’s credit score helps lenders determine if that person is a good fit for a product.
- They give consumers some sense of their creditworthiness. A person can get an idea of what products they might apply for, which ultimately depends on lenders using that score for underwriting.
The issue with a credit score is that it’s a singular number meant to demonstrate an individual’s creditworthiness. As an “average” of numerous factors, it doesn’t tell the entire story.
Why credit scores are flawed
The issue with a credit score is that it’s a singular number meant to demonstrate an individual’s creditworthiness. As an “average” of numerous factors, it doesn’t tell the entire story. A consumer can be highly creditworthy for some types of credit and non-creditworthy for others, which isn't communicated to potential lenders. Thus, lenders have a very limited understanding of a prospective borrower’s risk across multiple products.
An example
Let’s say we’re talking about a $500, $5,000 and $50,000 loan vs. a $5 million mortgage for one consumer. Consumers should have very different elements of creditworthiness for each product, but with a credit score, do not.
The idea of a lower credit score requirement for some products and a higher requirement for others might make intuitive sense. The problem is that it could leave out a lot of prospective borrowers who might be extremely creditworthy for smaller dollar, shorter duration loans. While they might be creditworthy for a credit card, they might be too risky for a mortgage. Their credit score, however, could prevent them from obtaining either.
In essence, the idea that a single credit score can capture a consumer’s creditworthiness is innaccurate, especially when a lender is applying that same score across multiple — and very different — products.
On the consumer side
For consumers, a way to see what types of products they might qualify for and, more importantly, what they can do to become more creditworthy, can be extremely helpful.
The real value is how a consumer can improve their likelihood of qualifying or getting approved for credit in the future.
An alternative solution
A single credit score isn’t enough to give lenders an accurate representation of a prospective borrower’s creditworthiness. While they might not qualify for a high-dollar loan, they could be perfectly creditworthy for small-dollar loans or a credit card. Unfortunately, their credit score might not show this, which is why lenders need a different approach.
Rather than thinking of a credit score as one number per person, a better way would be to score per credit product for one person. Then, lenders might get a more accurate picture of a borrower’s actual creditworthiness and ultimately, approve more borrowers without increasing risk.