What is a credit rating?

October 30, 2012

As another Halloween approaches, if you need to borrow money, issues surrounding your credit score can be mysterious if not downright scary—that is, if you're a sucker for superstitions and don't look into the facts. Credit score, credit report, credit history, credit record, credit file, creditworthiness, credit assessment, credit grade—credit this and credit that: The words are fatiguing.

Another monster under your bed is your ambiguous credit rating. The vague term is used in various ways in different arenas and disciplines to describe creditworthiness: The likelihood that that an entity will pay back a debt as agreed. According to the Securities Exchange Act of 1934 (15 USC, Chapter 2B), "The term 'credit rating' means an assessment of the creditworthiness of an obligor as an entity or with respect to specific securities or money market instruments."

Credit rating is often used to describe the overall financial health of a government. For instance, in 2011, it was widely reported that the United States lost its AAA (spoken "triple-A") status from the credit rating agency Standard & Poors.

With regard to consumers, the ephemeral, alleged credit rating is just one more arcane notion bandied about by so-called experts to describe a nebulous quality of a person's financial life. But the term credit score (also risk score) is specific, and refers to a single number that summarizes data in a consumer's file, seen in a consumer report (credit report).

In casual conversation, rating can be thrown in as a weasel word, or by the uninformed when they really mean score. If a banker asks, "How's your credit rating?," you would be hard-pressed to come up with an answer beyond excellent, good, average, fair or poor. Does good mean you have a high credit score but no savings? Or, does it mean that you have been on your job for ten years but have only an average credit score?

Try to answer these questions

• How is your credit rating?
• What is your credit score?
• What is your credit rating?

While they seem close, they ellicit different answers. For the first question, the answer might be "Good." For the second, "700-something" makes sense. But, for the third, the best response is, probably, "Do you mean my score?"

Consumer lending

In the consumer realm, the Fair Credit Reporting Act (15 U.S.C. § 1681 et seq.) uses the term credit score 58 times, and it is defined (p. 40). On the other hand, "credit rating" is used only once:

Free disclosure after adverse notice to consumer. Each consumer reporting agency that maintains a file on a consumer shall make all disclosures pursuant to section 609 [§ 1681g] without charge to the consumer if, not later than 60 days after receipt by such consumer of a notification pursuant to section 615 [§ 1681m], or of a notification from a debt collection agency affiliated with that consumer reporting agency stating that the consumer's credit rating may be or has been adversely affected, the consumer makes a request under section 609 [§ 1681g].

The Fair Debt Collections Practices Act (FDCPA) does not contain the terms "credit rating" or "debt collection agency."

In 1993, referring to the "somewhat sparse legislative history" of the Fair Credit Reporting Act (whose origin occurred 20 years before the FICO credit score), Administrative Law Judge Lewis F. Parker wrote

Senator Proxmire reintroduced the bill in 1969 with a modified definitional provision. The new definition appeared in two parts. The term "credit rating" was defined as "any evaluation or representation as to the credit worthiness, credit standing, credit capacity, character, or general reputation of any individual." "Credit report" was then defined as a "communication of any credit rating, or of any information which is sought or given for the purpose of serving as a basis for a credit rating." S. 823, 91st Cong., 1st Sess., 115 Cong. Rec. 2415 (1969). Again, the use of the terms "sought or given" indicates that the focus was on the intent of the credit bureau and/or the recipient to use the information, not on the actual content of the information. Moreover, this two-part definition suggests that this language was intended to expand the scope of coverage beyond what the bill denominated as "credit rating" information, not to restrict coverage to certain types or kinds of information, contrary to respondent's reading of it. And, finally, the definition of "credit rating" had expanded. It now included information about character or general reputation.

Wikipedia (a source of amusement more than of accurate information) sees rating and score as synonymous. In its article named "Credit history" under the section, "Calculating a credit rating," only the percentages of importance of categories in the FICO score are included. FICO scores use only information in consumer files (credit reports).

Fannie Mae and Freddie Mac, the government sponsored enterprises of the secondary mortgage market, refer to credit scores when referring to consumers ("borrowers"). Credit scores are the first sub-topic (even preceding credit reports) in the credit assessment chapter of the Fannie Mae Single Family guidelines. The guidelines use credit rating to refer to evaluations of a businesses like a title insurance companies and issuers of debt instruments (mortgage-backed securities). "Credit rating agency" is used in the glossary.

Unfortunately, consumer reporting agencies (the term in the FCRA) has the same initials as credit rating agencies: CRA. And, ignoring the law, big, influential institutions confuse terms for companies that produce consumer reports (aka credit reports). Inartfully, the FDIC refers to consumer reporting agencies as credit reporting agencies. The Federal Reserve, with its new-found authority over consumer reporting agencies, refers to "credit bureaus."

Other bureaus may not be very happy about being having to share that moniker (anybody can be a bureau; don't wait for congressional action to sound important). On its page titled, "Consumer Laws and Regulations: Fair Credit Reporting Act (FCRA)," the Consumer Financial Protection Bureau (a part of the federal government) mentions certain parts of 12CFR and 16CFR, portions of the Code of Federal Regulations.

16 CFR 322.4 (not specifically mentioned in the CFPB page) requires mortgage assistance relief service providers to provide the disclosure, "If you stop paying your mortgage, you could lose your home and damage your credit rating."

The most specific use of the term rating in the industry is one that at least one of the consumer reporting agencies uses. In its definition of "PAYPAT," the TransUnion Credit Report Training Guide states that it is a person's "payment pattern with his/her actual rating or Manner of Payment (MOP) over a period of time." "Payment Rating" in the Consumer Data Industry Association Metro 2 data format refers to the status of an individual account (p. 154).

Ranking vs. rating in credit scores

On the FICO Banking Analytics blog, a Fair Isaac official wrote, "Ranking held up well, but the rating side of the models didn't do so well."

The same official commented to the FDIC about "default rates for defined score bins."

Documented on the Credit Scoring Site, a TransUnion document (the link is no longer valid) illustrated the "DELINQUENCY RATE" for segments of its FICO credit score distribution.

The first sentence of a Federal Trade Commission document titled "Credit and Your Consumer Rights" is "A good credit rating is very important." The word score does not appear.

In 'Your Credit Score Is a Ranking, Not a Score,' the Federal Reserve Bank of Cleveland states, "Part of the apparent unpredictability comes from the common misunderstanding that a credit score is a rating of one's creditworthiness."

However, in the same piece, the author claims, inaccurately, that employers use credit scores. Adding to the confusion, even though the Wikipedia article "Credit score" states that "credit reports for employment screening purposes do not include credit scores," the Fed document is listed, prominently, as one of only 6 "External Links."

Missouri Attorney General Chris Koster thinks that a credit score is the same thing as a credit rating. Referring to consumer reports through annualcreditreport.com, his website states, "You will not see your credit rating (or credit score)." He makes the same error as the Cleveland Fed about employers.

Credit rating agencies

As with consumer reporting by Equifax, Experian and TransUnion, three names are often mentioned in the same breath with regard to government and business financial ratings: Standard & Poor's, Moody's and Fitch. In June, 2012, the U.S. Securities and Exchange Commission announced the appointment of the director of the commission's new Office of Credit Ratings. Ten companies are registered with the SEC as "Nationally Recognized Statistical Rating Organizations ("NRSROs")."

The credit rating agency Standard & Poor's ("S&P") calls ratings only "opinions," clarifying, "Ratings should not be viewed as assurances of credit quality or exact measures of the likelihood of default." The internet domain understandingratings.com was created on May 17, 2010 and is registered to Standard & Poor's.

On Friday, August 5, 2011, S&P lowered its "long-term sovereign credit rating" of the United States of America. A year later, the Associated Press said the downgrade "LOOKS LIKE A DUD."

Of its stock market barometer, the company claims, "The S&P 500 has been widely regarded as the best single gauge of the large cap U.S. equities market since the index was first published in 1957."

Not from the horse's mouth

In addition to the mention above by TransUnion, in a FAQ, the same consumer reporting agency refers to THE credit rating. In the U.K., "Equifax Credit Rating" is trademarked. However, despite the existence of the term in U.S. law, Equifax gives no definition of credit rating in its glossary. Ditto for Experian.

So, fans of clarity, boos to vagueness by industry, government and regulators. And Boo! Look out for your credit rating, the spooky thing that can haunt you like a ghost. This Halloween, what are you afraid of?

[see updates on this topic at blog.creditscoring.com/?tag=credit-rating]