Congress Wants To Ban Credit Scores | Major Changes Ahead

What's up, Grandma's guys? Here, so no surprise, your credit score is pretty much the single most influential deciding factor when it comes to all things personal finance, building wealth, and saving a ton of money. Those three numbers pretty much become like the gatekeeper that decides whether or not you buy a house, rent an apartment, obtain a credit card, leverage your money, and even, in some cases, get a job. But that might soon start to come to an end.

That's because a new report just revealed that 53 percent of Americans are getting turned down due to bad credit, and even worse, 45 million Americans have no credit score whatsoever, leading both Congress and big banks to take matters into their own hands and develop a completely new credit scoring algorithm that would replace the current system as we know it.

This new algorithm would allow people to get credit cards without having a credit score and take brand-new items into consideration that could either help or hurt you depending on your situation. Even more important, this is not just speculation or some random proposal from a no-name person in Congress; this is actually beginning to go into effect right now. So it's important that you understand exactly what's going on, how this is going to impact you, and the steps that you could take ahead of time to make sure you're in the best position possible to take advantage of this.

But really quick, if these types of credit card videos get you all charged up and you have an interest in learning more, make sure you swipe that like button for the YouTube algorithm by making it turn blue. Best of all, there are no hidden fees for doing that! Or just hit the like button if you want me to stop making these credit card puns, that works too. So thank you guys so much, and now with that said, let's begin.

Alright, so to bring you up to speed, for the last three decades, the traditional FICO scoring algorithm has been the go-to metric for determining your creditworthiness and how likely you are to repay back a loan. Pretty much from the age of 18, every single bank, lender, landlord, and utility company checks your credit score to determine how much they could financially trust you. If you don't meet their credit expectations, you're either stuck paying an absurdly high interest rate, or you're flat-out denied from doing business with them because you don't meet their qualifications.

Now, this entire concept of a credit score has been around for hundreds of years. Not to give you a history lesson or anything, but the story behind this is honestly really exciting. Fighting, see, in the past, like 200 years ago, your entire credit score was entirely dependent on your friends, family, and neighbors vouching for you that you could pay back your debts.

Eventually, as the system evolved throughout the early 1900s, the Retail Credit Company was born, and they kept the record on all the data they could find to determine whether or not someone was worth loaning money to or not. Now that database continually grew and expanded until the 1960s, when those records were sought to be digitalized for everybody to see.

But there was a problem because a person's credit score included everything from their late payments, their political beliefs, their personal character, their religion, their race, and even their late-night escapades. Consumers were furious, and that eventually led to the Fair Credit Act of 1970, which gave consumers more privacy and only reported certain financial transactions that would eventually fall off over time.

The Retail Credit Company also decided to change its name to Equifax, and then they carried on with the digitalization of credit information that was later tied together with Fair Isaac and Company in 1980, who compiled all three major credit reporting agencies into one report and created the FICO score that we now see and use today.

Now, even though we don't know the exact algorithm that gives you a precise credit score, we do know that there are five main metrics that have a significant impact on your credit score, and this is what they are.

Now, the first and largest factor is based on your on-time payment history, and that makes up 35 percent of your score. This just means you always pay your debts on time as agreed, without ever being late or missing a payment. The longer your history of on-time payments, the higher your score is going to be. If you miss a payment, that stays on your report for seven years, and the longer you miss the payment by, the worse it is.

The second largest impact is what's called your utilization rate, and that makes up 30 percent of your score. This calculates how much credit you have available to you versus how much of it you're actually using. If you're somebody who maxes out all of your cards or uses up pretty much all of the credit that's available to you, that is going to lower your score because you're seen as a riskier borrower.

Then third, we have the average age of your accounts, which makes up another 15 percent of your score. Lenders see that the longer you’ve had your accounts open for and in good standing, the higher the chances are that you're going to be a good, experienced borrower. So over time, as your accounts get more established, the higher your score is going to be.

Then fourth, we have the types of credit that you have, and that makes up another 10 percent of your score. This means that lenders want you to have experience handling different types of loans so that way you could prove to them that you're a financially responsible adult who knows how to pay their bills. For instance, it helps to have experience paying off multiple credit cards, an auto loan, a mortgage, a personal loan, and anything else you could throw into the mix. Basically, the more variety you have, the more experienced you are, and the higher the score you'll have.

Finally, we have the remaining 10 percent of your score, which is calculated by how many credit inquiries you have. See, anytime you go and apply for a new line of credit, it shows as a hard inquiry on your report. Now generally, the more hard inquiries you have on your report, the lower your score is going to be. But thankfully, though, credit inquiries only affect your score for the first few months, and then after a year, they have pretty much minimal impact.

Although now that you know how credit scores work and why they were put in place to begin with, here's the problem: and why traditional credit scores could soon be a thing of the past. First, it's important that it constantly changes every few years as it evolves and adapts. For instance, they recently made changes with FICO 8 that would ignore small unpaid balances of less than a hundred dollars.

In addition to that, FICO 10, which was just recently introduced, has the ability to see whether or not your spending is increasing over time, if your account balances are getting higher every month, and if you've been maxing out your accounts. But still, there are some major flaws with this, most notably that 45 million Americans don't even have a credit score, 40 percent have no clue how their credit score is determined, and 53 percent of them get turned down due to bad credit.

That means a significant portion of the population does not have access to affordable financing, the ability to buy a house, or the ability to leverage their money because they don't conform to the existing credit system, and that's something that big banks and Congress want to change.

The first is by offering credit cards to people with no credit scores. See, in the past, if you wanted to get a credit card, you first have to have a credit score, but if you need a credit score, you first have to have a credit card. So as you would expect, a lot of people were left out unless they knew the proper steps to take ahead of time. But under this new program, which would go into effect by the end of the year, banks would be allowed to take other aspects of a person's financial history into consideration, like their average account balance over time and whether or not they've ever overdrafted.

They hope that that would give a more realistic understanding of a person's creditworthiness and would open up more affordable financing options for borrowers in need. It's said that both Bank of America and JP Morgan have implemented something similar, having reviewed bank account balances in lieu of a credit score, and that resulted in credit card approvals for 700,000 additional customers since 2016. Pretty soon, that bank account data could be shared between companies, allowing you to get a credit card with another financial institution even if you don't directly bank with them.

Second, the government-sponsored housing agencies Fannie Mae and Freddie Mac are also considering allowing lenders to use different scoring options when evaluating new applicants. That's because they say too many people are left out of the credit scoring system, and as a result, they become reliant on high-interest payday loans and predatory lending, which further holds them back. In fact, some companies are even willing to take into consideration phone bills and magazine subscriptions as a way to gauge whether or not you'll pay them back, and it's working. Throughout the last decade, almost every credit category saw a boost in volume when alternative data was used in place of a credit score, and partially this was due to a new scoring algorithm called the Ultra FICO, which factors in how much cash you have on hand through checking, savings, and money market accounts. As a result, the number of customers with the subprime credit score has declined substantially.

Finally, third, Congress wants to take control of the situation by developing their own credit scoring models outlined in the "Need Protecting Your Credit Score Act of 2021." Congress says the current system is broken and should not be in the hands of a for-profit company to determine the likelihood of who should and should not get a loan. As a result, they want to ban credit scores from being considered on a job application, missed payments, and defaults would be removed after four years instead of the seven like it is now. They would limit the reporting of unpaid medical debt for up to a year and allow people temporarily impacted by COVID to have the credit file intact if they've claimed forbearance.

As far as when this could go into effect, how this is going to impact you, and whether or not it's a good thing, here's what you need to know. First, let's talk about the pros and cons, and I think it's reasonable that we start off with the good because this does solve a lot of issues.

One: a lack of a FICO score is not an accurate representation of how likely someone is to repay their debt. In fact, a credit score is only one small component of a person's overall financial stability. Other factors include that person's account balance, their spending in relation to their income, whether or not they've ever overdrafted from their account or bounced a check, if they paid their rent on time, or even if they've hit the like button for the YouTube algorithm. So I think it makes sense to take those aspects into consideration and incorporate that into a credit score to determine how creditworthy somebody is.

For example, I would much rather lend somebody money who has no credit score, but they keep ten thousand dollars in the bank and always pay the rent on time than it would be someone who has a 730 credit score but lives paycheck to paycheck and spends everything they make. These scenarios are not taken into consideration with the traditional FICO score, and that's something I think is worth considering.

The second thing is that it allows far more people access to affordable credit that could save them money. Like, as it is now, if you don't have a credit score and you need to borrow money, you have no other choice other than to resort to payday loans or high-interest price gouging to get yourself through. As a result, those people get held back even further for the exact same services even if they've never paid late in their entire lives. A new scoring model would help bridge that gap and give them more affordable options that would more accurately reflect their ability to pay.

The third thing is that by taking more data into consideration, in theory, your score should be even more accurate. Now, you would hope that this should boost your score and lower your interest rate if you've been an upstanding credit citizen. But the reality is, whatever current financial position you're in, this new score should more accurately reflect where you stand.

But on the downside, one, critics say that the new score would make millions of borrowers appear safer than they actually are, diluting the value of credit scores and reports. Right now, the effectiveness of a credit report is entirely dependent on erring on the side of caution, and if too many people get a boosted credit score without a proven track record, that could undermine the calculation while companies are on the hook for defaults.

Now two, according to TransUnion, consumers with thin credit files are more likely to default on their loans, even though the majority of them perform well. Even more interesting is that FICO estimates about a third of people who don't have credit scores had a major negative event like a bankruptcy at some point, which means they tend to be a riskier borrower, but not always.

Three, there's the very real possibility that banks and lenders just simply want to lend people more money, and they're looking for an easy way to do that that would allow them a brand new demographic of 45 million Americans who can now choose to borrow money based on new factors. Of course, that business is entirely dependent on those people paying them back, but opening up new credit options could come from the right intentions; it's just too early to tell.

As far as when this might happen, it's already happening. Like I mentioned, both Bank of America and JP Morgan have already started considering alternative information when considering new lending options, and that's expected to continue throughout the rest of the year and beyond. You know, even though Congress does want to create their own non-profit credit reporting agency that would create their own credit scores, as of today, it's just a proposal, and only time is going to tell whether or not something like this actually happens.

Now, personally, I'm a bit mixed on this, which is not something I usually say for a topic like credit scores. That's because on the one hand, I have been a part of this statistic that was credit invisible, even though I had a good job, I had money in the bank, and I had never missed a payment. It just so happened I was 21 years old and I didn't think I needed a credit card, and you guessed it: with no credit history at all, I could not get a mortgage.

That was a real wake-up call for me that I had to figure out how this worked so that that didn't happen again. But on the other hand, I've also spent the last 10 years using the credit algorithms to my advantage, figuring out how it works, always paying on time, optimizing my credit history, and eventually hitting an 800 credit score that gives me whatever loan I want.

So with the perspective of both, I do think that lenders should take alternative information into consideration. It makes sense that credit scores shouldn't just be limited to credit, and opening up the door for more information can't hurt and would benefit so many people who just get caught without a credit score. However, I also agree that there's no substitute for actually having the experience of managing multiple types of loans and various types of credit that brings a lot of value to those borrowers that should not be ignored.

In a perfect world, a steady account balance should be enough to qualify you for a small line of credit, and then from there, the usual metrics of on-time payment history and types of loans should go into effect. To me, it's a lot more important to focus on a solution that gets people from something to nothing. So from that perspective, this new scoring algorithm is a good thing.

But beyond that, experience does matter, and I think as long as we find a way to score or credit invisible people long enough for them to actually go and build up their credit history, I'm all for it. I think the more people that save money, the more people hit the like button, and the more people get their free stock down below in the description that is now worth up to a thousand dollars, the better.

So with that said, you guys, thank you so much for watching, I really appreciate it! As always, make sure to subscribe and hit the notification bell. Also, feel free to add me on Instagram; I post pretty much daily, so if you want to be a part of it there, feel free to add me there. As my second channel, The Graham Stephan Show, I post there every single day I'm not posting here. So if you want to see a brand-new video from me every single day, make sure to add yourself to that.

Thank you guys so much for watching, and until next time!