How The Credit Reporting System "Works"

The credit reporting system is a business relationship between two parties:

1) independent agencies that collect credit information called credit bureaus; and

2) merchants who pay for a copy of this credit information on an as-needed basis.

Credit bureaus refer to these merchants who pay a fee for their service as subscribers. As with any business, the main focus of the bureaus is to meet the needs of their customers, the merchant subscribers (not you).

When you apply for credit with a local merchant, the merchant turns to a credit bureau to obtain a copy of your "credit reputation" to help him evaluate the risks in extending credit to you. The bureau doesn't actually approve or deny your credit, but rather supplies the merchant with your payment history as reported by other subscribers with whom you have received credit. However, the bureau will use a closely guarded secret formula to assign a credit score to each individual based on the information in the file. This information is the most significant factor in the merchant's decision regarding your "ability and willingness" to meet your future financial obligations. The merchant is counting on the credit bureau's information to serve as a filter to help separate good credit risks from poor risks.

The shortfall of this system is that the product, you, has little clout in this relationship. The merchant's primary motivation is to avoid bad credit risks, and the bureau makes a profit by charging the merchant for helping him do that. The consumer has no positive financial impact on the bureau. Thus, while you are out of the loop, you are surrounded by it.

If that weren't enough, you also have to compete against human nature. Without documentation of errors, the bureaus are inclined to report information as reported by subscribers--assuming the negative. After all, the merchant/subscriber is not going to complain because he didn't like what he saw on your file and thus didn't extend credit and didn't lose any money. Any losses for not taking a risk are speculative and argumentative, certainly not tangible. The only decisions that might draw criticism from the merchant are the losses as a result of the bureau omitting some negative information that would have caused the merchant to have declined extending credit.

This is not intended to make the credit bureaus appear the great "evil empire" that some have made them out to be. They are huge bureaucratic companies whose policies have evolved from simple business economics and human nature. Every credit bureau desires to maintain as accurate information as financially feasible, but at the same time they realize the quality control limitations dictated by competition and operating costs. And they realize that if they do err, it is better to err on the negative side rather than the positive--if they are going to serve their subscribers' best interest. Although they want to develop as truthful a portrait of your credit history as possible, human nature compels them to give highest priority to recording any remarks that might be true and might keep their customer-base from entering into a risky credit arrangement. After all, that is their service, and nothing directly impacts their bottom line any greater.

It's much like having a mechanic check out an automobile before you make a decision to purchase it. The mechanic is put on the spot. If he tells you it's a good car, and it breaks down on you, then he looks bad. He'll never be burdened with your complaints about the three he blackballed, only the one he okayed--if it should break down on you.

Human nature compels him to go into the situation looking for what's wrong, not what's right. You are about to make a major financial decision based mainly on the information your mechanic gives you. Similarly, the merchant may be making a comparable investment based on the information provided by the bureau.