4 ms·

Credit scores make more sense if you think of them not as scores of your ability to pay back debt, but as scores of likely profitability for the creditor. Someo

Credit scores make more sense if you think of them not as scores of your ability to pay back debt, but as scores of likely profitability for the creditor. Someone who never carries a balance and never will pay the occasional late fee is less profitable and thus has a lower score.

merek 3y ago
I think you need to factor in risk. This is a simplistic example but demonstrates the influence of risk. Who would you rather lend a mortgage to? - Group A, consisting of people who prudently pay debts early - Group B, consisting of people who pay debts on their due date, and sometimes after Let's say you lend $100B to each group A and group B. Historical data might show that in aggregate, group A has a default rate of 1% and group B 5% (there's 5% chance that a person from group B defaults on the loan). Because of defaults (risk), you expect to lose $1B of principal on group A and $5B principal on group B. To break even, you need to charge group A interest that would at least offset their $1B loss, and charge group B interest to offset their $5B loss, hence group B's higher interest rate. One group is not automatically more profitable than the other. Group B might incur more costs such as late fees, but this only works against their ability to make future payments.
- TexanFeller 3y ago
  Risk is for sure a large component of profitability, I didn't mean to imply otherwise. But risk is not the only factor and credit scores often seem to track the total profitability curve better than the risk curve.
- orbisvicis 3y ago
  Totally outside my wheelhouse, but I'd imagine that interest on debt could eventually make group B more profitable if the default rate isn't too high. Or perhaps have group A partially cover the interest of group B because they're lower risk and likely have higher income. I imagine that late fees increase the cost of repayments while debt interest increases the number of payments thus not hindering the ability to make future payments.
- kristianbrigman 3y ago
  It’s more than that - banks used to have prepayment penalties. People with high credit scores are (probably?) also more likely to move, which means the bank may only get a couple years of interest until you pay it back (when you sell to buy a new house with a new mortgage), vs. people who stay in their house for many years. These things mean that someone with a lower score may be a better investment for the bank. If it sounds ridiculous… imagine that every month, all the mutual funds you are invested in shut down and gave you your money back (with interest), and you had to choose from a whole new set. Some of you probably do this anyways, but most people prefer to make the choice once and then just let it grow.
throwaway68911 3y ago
How to improve your credit score ... get credit cards and pay most of them off, but never close them. Once you have established credit you will then be offer 0 APR credit cards for 12 to 48 months. With a zero APR credit card that has a balance say of 10,000 your monthly minimum payment is 1% of that so $100. $20,000 $200 a month ... once the APR promo ends transfer it to another card with zero APR. Closing credits has hurt my credit so i keep them open and locked, as well establish email alerts on all of them for different scenarios to monitor them.
- silisili 3y ago
  Not necessarily. My credit today is good, but not perfect. I have trouble getting any new credit card. All for the same stated reason - too much available unused credit. I'm sure my score would dive if I closed a bunch, just pointing out that having a bunch isn't always a good thing.
  - throwaway68911 3y ago
    I subscribed to both the Experian and Transunion apps. Both I quickly open either app and lock or unlock my credit(Transunion allows you to lock/unlock Equifax too). I can also see my credit scores as much as I want and ensure that I am using no more then 30% of my total accumulated credit limit. For example say I have 10 credit cards equally $100,000 combined then as long as don't have credit debt higher then $30,000 my credit remains good to very good to excellent. Your score will be negatively affected if your debt went to 31K and higher. Another good thing is both apps alert me immediately when theres a change to my credit. I pay about $50 a month for both, expensive yet well worth it especially if your looking to buy a house(s) and you overall really care about your financial health/score for present day or the future.
    - orangepurple 3y ago
      I pay nothing for these services, have lived rent free for 3 years, purchase and pay off my credit cards to the tune of $2000 a month, and just bought a house hundreds of thousands over 500k with an interest rate 1.75% to 2% below what is shown on Google for the current rates for 30 year fixed rate. The lender credited me for all points. You don't need to waste 50 a month to make the bottom of the rate sheet. Just good negotiation skills and reasonable credit history.
hanoz 3y ago
That doesn't make sense. A credit card provider may profit more from a customer who carries a balance and maybe makes the odd late payment, but a mortgage provider inherently has a customer who carries a balance, and the ideal is a customer who makes payments on time every time, for the life of the mortgage.
- TexanFeller 3y ago
  There's sense in what you say and that's one reason why different scores are sometimes used for mortgages vs CCs etc. But one could also imagine ways in which zero risk creditors might be less desirable to mortgage lenders. They might be more likely to prepay the loan or refinance quickly and stop making those interest payments prematurely. I payed mine off massively early due to some good fortune - wonder if the mortgage company was annoyed they went through the laborious process of approving the loan and only got a few years out of it.
  - hanoz 3y ago
    Fair point. It's a sorry state of afairs when you have to speculatively reverse engineer the algorithms run by a state-sanctioned oligopoly of private firms holding your own data gathered with, at best, coerced consent, and artificially structure your affairs in an attempt to present yourself as a dependable and unadventurous cash cow
    - fuzzzerd 3y ago
      You accurately, amusingly, and concisely articulated the situation. In a way that underscores the absurdity of it.

merek 3y ago

I think you need to factor in risk. This is a simplistic example but demonstrates the influence of risk. Who would you rather lend a mortgage to? - Group A, consisting of people who prudently pay debts early - Group B, consisting of people who pay debts on their due date, and sometimes after Let's say you lend $100B to each group A and group B. Historical data might show that in aggregate, group A has a default rate of 1% and group B 5% (there's 5% chance that a person from group B defaults on the loan). Because of defaults (risk), you expect to lose $1B of principal on group A and $5B principal on group B. To break even, you need to charge group A interest that would at least offset their $1B loss, and charge group B interest to offset their $5B loss, hence group B's higher interest rate. One group is not automatically more profitable than the other. Group B might incur more costs such as late fees, but this only works against their ability to make future payments.

TexanFeller 3y ago
Risk is for sure a large component of profitability, I didn't mean to imply otherwise. But risk is not the only factor and credit scores often seem to track the total profitability curve better than the risk curve.
orbisvicis 3y ago
Totally outside my wheelhouse, but I'd imagine that interest on debt could eventually make group B more profitable if the default rate isn't too high. Or perhaps have group A partially cover the interest of group B because they're lower risk and likely have higher income. I imagine that late fees increase the cost of repayments while debt interest increases the number of payments thus not hindering the ability to make future payments.
kristianbrigman 3y ago
It’s more than that - banks used to have prepayment penalties. People with high credit scores are (probably?) also more likely to move, which means the bank may only get a couple years of interest until you pay it back (when you sell to buy a new house with a new mortgage), vs. people who stay in their house for many years. These things mean that someone with a lower score may be a better investment for the bank. If it sounds ridiculous… imagine that every month, all the mutual funds you are invested in shut down and gave you your money back (with interest), and you had to choose from a whole new set. Some of you probably do this anyways, but most people prefer to make the choice once and then just let it grow.

throwaway68911 3y ago

How to improve your credit score ... get credit cards and pay most of them off, but never close them. Once you have established credit you will then be offer 0 APR credit cards for 12 to 48 months. With a zero APR credit card that has a balance say of 10,000 your monthly minimum payment is 1% of that so $100. $20,000 $200 a month ... once the APR promo ends transfer it to another card with zero APR. Closing credits has hurt my credit so i keep them open and locked, as well establish email alerts on all of them for different scenarios to monitor them.

silisili 3y ago
Not necessarily. My credit today is good, but not perfect. I have trouble getting any new credit card. All for the same stated reason - too much available unused credit. I'm sure my score would dive if I closed a bunch, just pointing out that having a bunch isn't always a good thing.
- throwaway68911 3y ago
  I subscribed to both the Experian and Transunion apps. Both I quickly open either app and lock or unlock my credit(Transunion allows you to lock/unlock Equifax too). I can also see my credit scores as much as I want and ensure that I am using no more then 30% of my total accumulated credit limit. For example say I have 10 credit cards equally $100,000 combined then as long as don't have credit debt higher then $30,000 my credit remains good to very good to excellent. Your score will be negatively affected if your debt went to 31K and higher. Another good thing is both apps alert me immediately when theres a change to my credit. I pay about $50 a month for both, expensive yet well worth it especially if your looking to buy a house(s) and you overall really care about your financial health/score for present day or the future.
  - orangepurple 3y ago
    I pay nothing for these services, have lived rent free for 3 years, purchase and pay off my credit cards to the tune of $2000 a month, and just bought a house hundreds of thousands over 500k with an interest rate 1.75% to 2% below what is shown on Google for the current rates for 30 year fixed rate. The lender credited me for all points. You don't need to waste 50 a month to make the bottom of the rate sheet. Just good negotiation skills and reasonable credit history.

hanoz 3y ago

That doesn't make sense. A credit card provider may profit more from a customer who carries a balance and maybe makes the odd late payment, but a mortgage provider inherently has a customer who carries a balance, and the ideal is a customer who makes payments on time every time, for the life of the mortgage.

TexanFeller 3y ago
There's sense in what you say and that's one reason why different scores are sometimes used for mortgages vs CCs etc. But one could also imagine ways in which zero risk creditors might be less desirable to mortgage lenders. They might be more likely to prepay the loan or refinance quickly and stop making those interest payments prematurely. I payed mine off massively early due to some good fortune - wonder if the mortgage company was annoyed they went through the laborious process of approving the loan and only got a few years out of it.
- hanoz 3y ago
  Fair point. It's a sorry state of afairs when you have to speculatively reverse engineer the algorithms run by a state-sanctioned oligopoly of private firms holding your own data gathered with, at best, coerced consent, and artificially structure your affairs in an attempt to present yourself as a dependable and unadventurous cash cow
  - fuzzzerd 3y ago
    You accurately, amusingly, and concisely articulated the situation. In a way that underscores the absurdity of it.