How Credit Scoring Came To Be
After the reading the above examples you are probably wondering how one little three digit number can have such an impact on a person’s life.
Credit scoring is not new. It has been affecting our lives for the past several decades. By the late 1970s almost all major lenders were using credit-scoring formulas to assess a person’s trustworthiness and financial situation. Before that were the good old days where you could practically talk your way into getting a loan from the local bank manager.
The invention of credit scoring is generally attributed to two main leaders in the business – mathematician Earl Isaac and Bill Fair. This team founded a company called Fair Isaac in 1956 and everything that this company created could be said to be responsible for the way credit scoring, credit bureaus and the acquisition of credit is handled today.
Fair Isaac is the company responsible for convincing lenders in the first place that they needed some kind of equation to determine the probability of a customer defaulting on a loan or not. Originally, the system was supposed to be fool proof and free of prejudice. A good credit risk could not be turned down because of race, religion or color or accepted because he or she had political connections or a friend. The entire rating system assessed a person’s ability to keep financial promises only.
Lenders everywhere opted to adopt the Fair Isaac credit scoring method, otherwise known as FICO scores in the mid 1980s. This was because it was considered to be a lot faster process when it came to calculating whether or not someone was a risk when it came to credit. The Fair Isaac Model of Credit Risk allowed lending decisions to be made in minutes, rather than in the weeks that it used to take to thoroughly research the financial history of an applicant. Furthermore, the computer age was making calculations and financial record keeping easier and thus made the FICO system easy to for lenders to implement.
Initially different creditors had their own systems of determining your worthiness in terms of credit. In the seventies and eighties, that one car lender offered in terms of a loan could be vastly different than another simply because they had a different database or different criteria when it came to assessing whether or not you were a good credit risk.
As it became more and more of a hassle for businesses and lenders to maintain their own credit databases, three companies sprung up to specifically manage the databases involved. After Fair Isaac developed the first credit bureau based scoring system in the mid 1980’s it was not long before the three credit bureaus that we still deal with today came into existence – Equifax, Experian and Transunion.
Fair Isaac’s scores (FICO for the Fair Issac Credit Organization) were a success because they had invented a model of credit rating that was not based on any single lender’s experience but instead on the experience of all of the lenders who had dealt with the individual in question. The model of credit rating, still used today to assess credit risk, looked for patterns of behavior that a borrow was likely to default as well as patterns that indicated the person was likely to pay it back. Counted among this information was the person’s history of paying bills on time, the number and type of credit accounts that he or she was maintaining as well as how much available credit the customer was using on a regular basis.
Soon it became apparent to creditors that this type of calculation according to a database could also be useful when it came to charging higher amounts of interest to desperate individuals who were considered to be high risk.
Ultimately this type of credit scoring also became a useful source of information for credit card companies who could then find potential borrowers and send them credit card offers through the mail to try and convince them to enroll at certain interest rates.