Consumer X pays his bills on time, never revolves a balance from one month to the next, enjoys FICO scores close to 800 and, unfortunately, will lose his house to foreclosure in six months because when his loan terms reset next month, he will no longer be able to afford his payment. Consumer Y uses credit cards to live a lifestyle he can’t afford, lied about his income on a mortgage application and now lives in a house more fitting for a rock star than an average Joe. He, too, will lose his house to foreclosure in six months because his lavish lifestyle has caught up to him.

These two consumers are completely different credit risk-wise. The only thing they have in common is that they will both have foreclosures on their credit reports for the next seven years. Well, here’s something else they have in common: there is no way to simply look at a credit report and understand why one consumer lost his home versus why the other consumer lost his home. From a credit perspective the foreclosure looks the same, with no backstory.

This issue is more common now than ever before. People are losing their homes because of reasons other than poor credit management. Despite a fairly sophisticated credit reporting system there is no real way to tell the difference between someone who happened to work in a failing industry versus someone who failed credit management 101.

Having said that, this is the same issue with everything negative on a credit report. Who knows why you defaulted on your credit cards, why your car was repossessed and why you now have a bunch of collections. There is never a backstory.

The question some are asking is will this impact the development of credit scoring models over the next 3-5 years? The argument is that many foreclosures are happening to people who will never miss a payment again. What they’re missing is that these people will see their scores drop less than those who are habitual late payers. And, their scores will recover more quickly because they won’t realize any new negative events.

Regardless, in the grand scheme I don’t think it’s going to cause a problem because the real value of the credit score isn’t the score itself, it’s the interpretation of the score by the lenders who are using it. Just because I have a foreclosure and have a score of 650 it doesn’t mean that all lenders will treat me the same way. Some lenders will be able to sniff out that some 650s are better than some 680s by using other types of complementary scoring models and underwriting criteria.

So for consumers who have lost their homes because they chose the wrong job or married the wrong spouse or invested with Bernie Madoff, don’t worry too much. Banks, especially the bigger ones, are sophisticated enough to figure out that you’re not the same level of credit risk as the guy who used to live next to you in your neighborhood who now sleeps in his Bentley, which will probably get repossessed next week.

John Ulzheimer – Credit scoring and credit reporting expert and author, John is the President of Consumer Education for Credit.com. Formerly with Equifax and Fair Isaac, John shares his unique insight of the inner workings of credit scoring models and the credit reporting industry on CreditBloggers.com.