Credit Scoring

You may wonder how a creditor can look at all the information on your credit report and make a fair decision about your credit. Along with the credit report, lenders can also buy a credit score based on the information in the report. Credit scoring is a scientific method that uses statistical models to assess an individual's credit worthiness based on their credit history and current credit accounts. Credit scoring was first developed in the 1950s, but has come into increasing use in the last two decades.

A computer-generated score is compiled using information from an individual's credit report. Creditors-especially those in the mortgage industry-frequently use the scores when deciding who receives loans.

Why is credit scoring used?

By using credit scoring, a lender can quickly and objectively evaluate your credit history in a consistent manner, and determine the likelihood that you will repay the loan as agreed. The use of credit scores not only improves the accuracy of the analysis of your credit history, but does so in a way that enhances the efficiency and consistency of the underwriting process.

Credit scoring also protects you. This is because your age, health, race, religion, gender, national origin, marital status, income, and employment are not considered in determining your credit score.

Advantages of Credit Scoring

The widespread use of credit scoring allows for speedy, objective analysis of credit histories.

Credit scoring has allowed companies to offer "instant credit," which was unheard of in years past. As you browse through aisles of washing machines or peek into the windows of new cars, a prospective lender can order your score and, if they like what they see, give you loan or credit approval on the spot.

It also means that borrowers are less likely to experience problems with individual lenders' prejudices since it does not take into consideration race, gender, religion, national origin, marital status and whether or not the applicant is receiving public assistance.

Because credit scoring is objective and based on large volumes of verified statistical data, credit scoring brings a new level of fairness to the credit-granting process.

How is a credit scoring model developed?

To develop a model, a creditor selects a random sample of its customers, or a sample of similar customers if their sample is not large enough, and analyzes it statistically to identify characteristics that relate to creditworthiness. Then, each of these factors is assigned a weight based on how strong a predictor it is of who would be a good credit risk. Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.

Key Points

• Your credit score is determined by a combination of many factors. No one piece of information or factor will determine your score.

• Credit scoring systems assign points to factors that help predict who is most likely to repay a debt. Your credit score helps predict how likely it is that you will repay a loan and make the payments when due.

• Your score only looks at information in your credit report. Lenders, however, look at many things when making a credit decision, including your income and the kind of credit you are applying for.

• The most commonly used scoring systems give you a number from the mid-300s to the mid-800's, with high scores being better. Scores vary depending on the type of credit you are seeking. For example, recent auto loan history is weighed more heavily when applying for a car loan.