Written By: Stephanie R. Yates, PhD, AFC®, CFP®
In this collection of research articles, we see the impact of credit education on consumers. All three articles find differences across demographic groups with respect to credit. Younger, older, low-income, and minority consumers tend to have less credit education and lower credit scores or no score at all. This lack of knowledge also appears to lead to poor decision-making, but not necessarily more vulnerability. These studies provide concrete information supporting the need for counselors to help clients regularly review their credit reports and scores and make wise decisions with regard to using and managing credit.
“The Cost of Not Knowing the Score: Self-Estimated Credit Scores and Financial Outcomes” by Benjamin Levinger, Marques Benton, and Stephan Meier (Journal of Family and Economic Issues, 2011)
This article considers the impact of self-estimating one’s credit score given that although the FACT Act of 2003 gives consumers the right to a free annual credit report, it does not allow free access to credit scores. Therefore, the authors argue that despite the implementation of the FACT Act, consumers are still largely unaware of their true credit worthiness. The authors hypothesize that consumers then underestimate their credit score with leads to poor financial decision-making.
To test their hypothesis, the authors surveyed low-to-moderate income taxpayers who participated in a free credit-advising program linked to the Volunteer Income Tax Assistance (VITA) program in Boston, Massachusetts in 2008 and 2009. This resulted in 1,767 study participants. The authors administered surveys to the participants before providing them with their credit reports and scores. They asked participants to estimate their credit scores and asked questions regarding their credit behaviors.
The authors found that 73% of the participants underestimated their credit score and 55% of them underestimated by more than 50 points. They also found that those who underestimated their scores were more likely to believe that issuers would deny them credit and therefore chose not to apply. Those who underestimate their credit scores also pay higher interest on credit cards.
“Credit Invisibles and the Unscored” by Kenneth Brevoort, Philipp Grimm, and Michelle Kambara (Cityscape 2016)
This article analyzes consumers with limited credit histories. It defines credit invisibles as consumers without credit records. It defines the unscored as consumers whose credit records do not contain sufficient information to allow scoring by conventional credit-scoring models. Further, the authors breakdown the unscored population into the insufficient-unscored and the stale-unscored. The insufficient-unscored have insufficient information in their credit file to generate a reliable score. The stale-unscored have no recently reported information.
The authors used three sources of data for the study: 1) a random sample of deidentified credit records from the Consumer Financial Protection Bureau Consumer Credit Panel; 2) 2010 Census data; and 3) the 2008 – 2012 American Consumer Survey. Based on this data, the authors estimated how many consumers in the United States have limited credit histories and profiled their demographic characteristics. Then, they used multivariate analysis to determine the factors associated with the likelihood of having a limited credit history.
They found that 45 million adults in the US have a limited credit history and that this result varies with age, race, and ethnicity. Of those 45 million adults, they found that 26 million fall into the “credit invisible” classification and 19.4 million are “unscored”. Further, they found that a nearly even split in the unscored population between those who are unscored due to insufficient information versus those who are unscored due to stale information.
These findings are significant due to the importance of credit for clients. Nearly 20% of the US population lacks a credit reputation, which makes it difficult for them to realize goals related to major purchases.
“Credit Usage, Payment Behavior, and the Accuracy of Consumer Credit Files” by L. Douglas Smith, Michael Staten, Thomas Eyssell, Maureen Karig, Jeffrey Feinstein and Cathleen Johnson (Financial Services Review, 2018)
This article examines how different segments of society engage in the consumer economy, manage obligations are vulnerable to errors and resolve those errors with respect to credit. Specifically, the authors consider how different consumer groups manage credit, if certain groups are more vulnerable to inaccuracies than others are, and if certain groups are more likely to see positive results in credit disputes.
The authors interviewed 1,001 individuals from across the United States regarding their credit reports and credit habits.
They found that credit usage depends somewhat on socio-economic factors but varies with education, income, family resources, and ethnicity. They found that the credit record is highly related to family resources, household characteristics, demographic attributes, occurrence of adverse events, and self-reported credit habits. They also found that the propensity to identify errors in credit records relates to the nature of the person’s credit record rather than the demographic characteristics of the person. That is, using credit without paying off all balances each month tends to make consumers more vulnerable to the reporting of derogatory information in the credit file and therefore more prone to errors. This is significant because the authors found that just 46% of those surveyed reported paying off all account balances each month. Similarly, they found that dispute outcomes relate to the credit record rather than to the demographic characteristics of the consumer. In addition, individuals with very poor or exceptionally good credit are less likely to see material differences in their credit score due to corrections. However, 5.5% of the sample saw their credit score cross a threshold to more favorable terms after correcting errors in their credit files. Unfortunately, less than one in six of those surveyed reported that they had reviewed their credit report in the two years prior to joining the study.
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