Credit scores are about to shoot up for millions of Americans with tax liens and/or civil judgments on their credit reports.
Earlier this year, the three major credit bureaus laid the foundation for this change by starting the National Consumer Assistance Plan (NACP), a policy organization started by the big-three credit bureaus – Experian, Equifax and TransUnion – that calls for changes to the way certain information is used on your credit history.
Part of that plan addressed tax liens and civil judgments, two types of derogatory marks that will be removed from many credit scores on July 1, 2017.
According to data group LexisNexis, 98% of civil judgments will be removed and 50% of tax liens will disappear from credit reports.
We found this bit of news quite interesting because it brings up several questions that directly affect you, the consumer:
- What is a tax lien?
- What is a civil judgement?
- Why are they being removed from your credit history?
- How will it affect your credit scores?
Part of the reasoning behind this change is that some consumers have incorrect tax liens and judgments on their credit history but even consumers with accurate information will have their judgments and liens removed on July 1.
This interesting twist made us wonder how the new change will affect lenders, whose job it is to give money to consumers based on your risk. Will removing accurate information give risky consumers better credit scores?
To answer all the questions we’ve posed, we reached out to experts through email and phone to get their opinion on the matter.
Over the next few minutes, we’ll include our research-based observations as well as those of other experts.
What Is a Tax Lien and How Does It Affect Your Credit Scores?
Anytime you hear the word “lien” think, “claim to ownership.” That phrase implies there are two things at play: the person making the claim and the thing being claimed.
An IRS tax lien kicks in when you don’t pay your taxes; the IRS stakes a claim or “lien” on all or some of your property.
A tax lien, in relation to your credit scores, is what’s known as a “derogatory mark,” something that shows up on your credit history and, consequently, lowers your credit scores. Over time, the impact of the derogatory mark weakens, but, in many cases, it won’t disappear until seven years after the fact.
What is a Civil Judgment and How Does It Affect Your Credit Scores?
A civil judgment is what happens when you don’t pay a debt you have and the company collecting that debt takes you to court to ensure they get the money you owe them.
It’s basically a legal decision saying you have to pay the company back. If you go to court and have a civil judgment against you, that information goes on your credit report.
Consider civil judgments the worst of the worst in terms of payments – they only happen after you’ve defaulted on your account, your account has been charged off and sold to a debt collector and the debt collector has been unsuccessful in getting your payments.
Why Are Tax Liens and Civil Judgements Being Removed From Credit Reports?
The removal of tax liens and civil judgments from credit reports is the result of Experian, Equifax and TransUnion’s beefed up NCAP standards that are designed to “ensure the data they maintain on their consumer credit files is accurate and current,” a March, 2017 press release from the Consumer Data Industry Association said.
Per this mission, they decided to enhance their “public record data standards for the collection and timely updating of civil judgments and tax liens.”
That enhancement includes the following two guidelines that must be fulfilled in order for liens and judgments to remain on credit reports.
These guidelines are applied to tax liens and civil judgments in the public record that are reported to the credit bureaus:
- Have to include the consumer’s name, address and date of birth or SSN
- Courthouse must check and update records at least every 90 days
If either of those conditions is not met, then the records can be removed from the consumer’s credit score.
John Ulzheimer, a well-respected expert in credit scores and a source with whom we’ve spoken in the past, said there’s a good chance most records – even accurate ones – will be removed because of the stringent new rules.
“The credit bureaus have self-imposed minimum data standards in order to collect and maintain liens and judgments,” Ulzheimer told us in an email. “Those minimum standards are very strict and, as such, most judgments and half of liens cannot comply and will be removed.”
Strict Credit Report Standards Protect Consumers
The specific minimum data standards will be a big help to consumers who’ve had to deal with incorrect tax liens or civil judgments placed in their credit history.
For example, it’s conceivable that a civil judgment could show up on your credit report because the courthouse providing the information only gave a name and that name happens to match yours.
So, by requiring that all reported civil judgments and liens have the consumers name, address and DOB/SSN, you’re guaranteeing there aren’t any mix-ups and innocent consumers aren’t hit with derogatory marks.
Strict Standards Mean Even Accurate Information Will Be Removed From Credit Reports
Like Ulzheimer, Consumer Union Policy Analyst Maureen Mahoney expects that nearly all civil judgments will be removed and about half of tax liens will disappear.
“Making sure that credit reports are accurate is of key importance, and we expect that these practices will help improve accuracy going forward,” Mahoney told us in an email. “The burden should be on creditors and credit bureaus to be able to document that a consumer’s credit report only includes information that belongs to the consumer.”
Small Percentage of Consumers Have Incorrect Judgments/Liens on Credit Report
Here’s the interesting part: Mahoney referenced a 2012 article from the Columbus Dispatch that said around 15% of filed credit report complaints cited errors with court records. Another 25% of those people said their credit reports showed court judgments/records that weren’t theirs.
In other words, only about 4% of consumers who filed complaints about inaccurate information on their credit report actually had somebody else’s court judgment on their credit history.
So, nearly all civil judgments are being removed because less than 4% of consumers who filed complaints about their credit reports had court judgments wrongly associated with their credit report.
Yet, nearly all civil judgements will be removed from consumers’ credit reports on July 1, which tells us that correctly reported liens and judgments will be deleted from credit reports.
The total number of credit reports that will see increases? Around 11 million.
LexisNexis says removing liens and judgments will raise scores at least 10 points on average and that nearly half of consumers with scores below 620 will see their score rise at least 20 points.
This is a win for the consumer, right? Many people are benefitting from reporting standards brought about by the complaints of a few.
However, when it comes to credit scores, we often forget that there is another group of people who are affected by wholesale changes to credit scores: the lenders.
How Will the Change in Credit Scores Affect Lenders?
We read through the CDIA’s press release about the upcoming changes and noted that they said they’ve been working with financial institutions to explain the changes.
According to that release, the changes shouldn’t be a big deal.
“We believe the enhanced standards for record accuracy while at the same time ensuring that creditors can continue to rely on credit report data and credit scores derived from the data,” the CDIA wrote.
So, consumers get the benefit of seeing some really ugly information removed from their credit report and lenders don’t have to worry too much about the changes, right?
Not so fast, says Catherine McDermott, president and CEO of Virginia-based RiverTrace Federal Credit Union.
You see, from a lender’s perspective, consumers are seen as credit risks. Good credit risks are consumers who pay their loans back on time. Bad credit risks are consumers who don’t.
“Just because someone’s credit score is magically improved because of the removal of liens and judgments doesn’t make them a better credit risk,” McDermott told us. “It’s been proven time and again that consumers with liens or judgments are twice as likely to default as consumers who don’t have any on their credit reports.”
That’s right: Consumers who have judgments or liens on their credit report are two times more likely to stop paying their loan or credit card as someone with a squeaky-clean credit history.
Now, the past decade has been an exercise in bank-hating – consumers were fed up with greedy financial institutions taking advantage of consumers through self-centered asset decisions and a crazy number of fees and charges.
However, that ire doesn’t change the fact that, for the average consumer, a bank or credit union like the one McDermott runs is a place where you store money and borrow money.
An Example of How Deleted Credit Report Information Can Hurt Lenders
So, let’s say in a made-up world you’ve got a friend of a friend who wants to borrow $500. Just like always, you do some investigative work to find out if this person is good for the amount. Will they pay you back, or will they take the money and run.
Well, in this fictional world we’ve created, people who’ve borrowed money and didn’t pay it back are supposed to have a red flag on their Facebook profile. Consider this the derogatory mark they’d normally have on their credit scores.
Why is this mark so important? Because people with the red flag are twice as likely to not pay you back.
One day, Facebook decides to remove these flags because there have been some isolated cases in which red flags were accidentally given to the wrong profile. The friend of a friend wins, but you lose.
Why 20 Points Makes a Big Difference
Dara Duguay, executive director of Credit Builders Alliance, says that most scores won’t be changed by more than 20 points and that less than 11 million consumers will be affected.
How big of a difference do those 20 points make?
Catherine McDermott told us that increase could bump a consumer up into the next credit-rating tier, making financing available to them that they wouldn’t have been able to get before.
Her credit union ranks consumers based on a letter grade: D, C, B and A are examples.
“If someone comes across our desk with a D credit score, we automatically turn them down,” McDermott said. “When July 1st rolls around and that same person comes along and the judgement or lien is gone, their score will improve because those previous marks won’t drag the historical data down and they’ll cross the threshold from a D borrower to a C borrower.”
Crossing that threshold means access to better rates and terms on loans and credit cards. A jump from bad to fair credit, which can happen with a good 15 or 20 points, can put you in the running for fair-credit credit cards with far better terms than credit cards for bad credit.
Credit Scores Change, Habits Stay the Same
Now, you might be thinking this is actually a good thing: the average consumer gets a better score and better financial products.
However, better credit scores don’t equate to better spending habits, and it’s those habits, McDermott says, that will lead to the undoing of the consumer who crossed from D to C when accurate information was deleted from their credit history.”
“We’d grant them the loan and, because of their poor payment history, they’d fall into that same pattern and ultimately go into delinquency,” she said. “(The new rules) really muddy the water due to the fact that you aren’t getting the full view of this person’s credit history.”
And when a new wave of consumers comes and defaults on their loan/credit obligations, good consumers suffer.
“We’ve now granted them credit they can’t pay, which will put them in default and will be a problem for the credit union in terms of charge offs,” McDermott said. “Financial institutions will suffer losses and that will cause rates to go higher for good consumers.”
Our Final Thoughts: Are the Changes to Credit Scores a Good Thing for Consumers?
We’ve wrestled with this question because there are so many things at stake with credit scores.
The new standards will definitely help consumers with bad information incorrectly assigned to their credit report, but it will also help consumers who have bad information correctly assigned to their credit report.
While the bump in credit score may be nice for consumers who actually do have tax liens and civil judgments, it puts lenders in a tough spot because liens and judgments represent a significantly higher rate of default.
Without knowing if a consumer has had a tax lien or civil judgment, financial institutions like RiverTrace could be giving loans to people whose credit scores don’t accurately reflect their spending and debt-management habits.
The more loans and lines of credit that go into default, the higher the cost for the financial institution and, consequently, the higher the rates for irresponsible and responsible borrowers.
However, says John Ulzheimer, information network LexisNexis has responded to the imminent changes by creating a product that allows financial institutions to do thorough public records searches to figure out if potential borrowers have judgments or liens that don’t show up on their credit reports.
“Lenders have to decide on their own if the potential for a missing public record is problematic enough to go out and check for the data on their own,” Ulzheimer said. “In fact, LexisNexis has already announced a service to do just that.”
The service he referred to is called the RiskView Liens & Judgments Report. According to the company’s site, they can provide information about liens and judgments that is 99% accurate.
“If I ran a credit reporting agency I would have immediately begun working on a project to comply with the personal identification indicator and verification requirements of liens and judgments so I could get them back on consumer credit reports,” Ulzheimer said.
The Basics of Credit Scores and Credit Bureaus
Is your head spinning from all this talk of credit scores, scoring models and derogatory remarks? Don’t worry; it’s normal. We’ve spent hours and hours researching credit scores and there are still parts of that world that confuses us and require some clarification.
As we’ve studied credit scores we’ve managed to pick up a lot of helpful information along the way via interviews and online research. The articles listed below are most pertinent to our discussion here. Each one is an in-depth, easy-to-read guide:
- What is a Credit Bureau? Understanding TransUnion, Equifax and Experian
- What is a FICO Score? The Most Important Credit Score You’ll Ever Need
- How to Get and Keep a Good Credit Score
- How to Repair Your Credit and Raise Your Score: Step-by-Step Guide