Credit Scores: Why the Latest Fixes Fall Short

More consumers than ever this year will see how their credit scores are used to determine their interest rates and loan terms. But the effort to provide more clarity may instead lead to more confusion.

For several years, people have been entitled to an annual free credit report from each of the three credit bureaus. (They can request it at AnnualCreditReport.com.) But they almost never got a free credit score unless they were applying for a mortgage.

Consumers typically have to pay up to $20 a pop for a FICO score, the industry standard developed by Fair Isaac. The score—which is intended to predict your ability to pay—is calculated based on the data in your credit report, which contains payment records, balances, account information, bankruptcies, and other details.

Even then, the score consumers received might have been quite different from what lenders got because there are different scores for car loans, mortgages, insurance and credit cards. In addition, each of the three credit bureaus sells scores to consumers that aren't FICO scores.

Now, under a Fair Credit Reporting Act rule that took effect Jan. 1, lenders must either tell those who apply for credit exactly what score was used, or explain how credit reports were used if the applicant doesn't receive the best terms available.

Under a provision of the Dodd-Frank financial-overhaul law that takes effect in July, all consumers who are turned down or don't get the best terms because of a credit score will get a copy of the credit score used, as well as information about where their scores fall among all consumers.

Fair Isaac estimates that 500 million such notices will go out to consumers this year, says Careen Foster, FICO's director of scores product management.

While the new disclosure requirements are a huge improvement, they are akin to having only one team's score in an athletic event. Here are some reasons why credit scores are likely to remain as opaque as ever:

• Learning the FICO score the lender used—a number between 300 and 850—still won't tell you what your lender makes of your score.

For instance, some lenders may give the best rate to people with a FICO score above 740, while others may use a cutoff of 760 or higher. Some may grant credit to people with scores in the high 500s, while others require 620 or more. And while those with scores between 760 and 850 often get the same terms, there may be several tiers of interest rates offered to those with scores between 620 and 760.

In short, a few points on your score may mean the difference between a good rate and a so-so one—but lenders won't tell you where they draw those lines.

• Credit scores still don't reflect whether you are making good financial decisions or poor ones.

Sure, some of the key components of scores are basic common sense: Pay your bills on time, don't apply for credit you don't need, and try to keep your level of borrowing well below your credit limit.

But there are inconsistencies that can trip you up. For instance, refinancing your mortgage to a lower rate may improve your finances, but it also will cause credit inquiries to show up on your report, which could lower your score.

Late payments can affect your score for a couple of years, while paying down a high balance can have an immediate positive impact. Yet that, too, can be misleading: If you pay your bill in full every month, you may not think you carry a balance. But lenders don't report the real-time balance that you see online. They report the amount that you owe at the end of your billing cycle.

And if you use your credit cards heavily to take advantage of reward offers, you could be penalized, even if you pay the amount in full every month. "You look no different than somebody with a big fat balance," says John Ulzheimer, president of consumer education at SmartCredit.com, which sells credit-score monitoring services based on its own scoring formulas.

• The free score that a lender provides means less than meets the eye, since consumers and lenders don't buy the same scores. If you want to see another score later on, you will have to pay for the privilege.

The credit bureaus and Fair Isaac (through its MyFico.com site) may offer "free" score updates, but only under trial offers for monitoring services that cost $14.95 or more a month. Generally, though, you don't need to know your score on a day-to-day basis. What you really need to know is your score around the time you will be applying for credit.

You will be much better off making sure the information on your credit record is correct, your payments are on time and your monthly balances are reduced for a month or two before you might be applying for a new mortgage, car loan or credit card.

Write to Karen Blumenthal at karen.blumenthal@wsj.com