Scoring Some Credit
By Jill Terry
In 1956, two guys with a penchant for statistics devised a system to predict whether certain people would pay their bills. Bill Fair and Earl Isaac founded Fair, Isaac and Company, and credit scoring was born.
But what is it and how does it affect you, the credit applicant? Scorecards are created by companies like Fair, Isaac and Company (or FICO) using statistical information based on the performance of consumers with similar profiles. The scoring system (or card) awards points for high performance according to certain factors. The total number of points an applicant scores indicates the probability that the applicant will repay his or her debt.
You might wonder what these mysterious factors are and how the scorecards are compiled. The law allows any “empirically derived, statistically sound” variable to be a factor in a credit scoring system–this phrase simply means that the variable has been tested thoroughly enough to prove that it’s reliable as a predictor of debt repayment.
Although race, religion, gender, and marital status cannot be used as variables, age can be. Surprisingly, even occupation, employment history, and education level may serve as components in a credit scoring system. Not surprisingly, your credit history is generally the most heavily weighted factor.
FICO develops generic scorecards that it sells to those in the business of extending credit, but it also customizes scorecards for companies with enough lending history to fit the “empirically derived, statistically sound” category. In other words, not all scorecards are the same. What may matter to one bank may not matter as much or at all to another. This variation makes it difficult to know how you’ll rate when you apply for credit at any given financial institution.
Banks vary in how heavily they rely on credit scoring systems. Larger banks often rely exclusively on electronic credit-scoring systems because of the speed they offer. Other financial institutions may use credit-scoring systems to cull the “first cut” of applicants: those who score above a pre-determined amount automatically get approved while those at the very bottom of the scale are declined. Applicants who fall in the middle range are then evaluated by a bank employee.
Supporters of credit-scoring systems cite objectivity as the system’s primary benefit. In an industry where allegations of discrimination have long been present, credit-scoring systems insure that standards will be applied equally and without regard to race, religion, gender, or marital status. System detractors, however, aren’t so easily convinced. Because the process is automated, oversights and glitches do occur on occasion, leading some people to claim that credit-scoring systems are too impersonal to be reliable or useful. So, how can you be sure to score high enough to get the credit you seek? Credit is credit, no matter how it’s evaluated, so the old rules under more judgmental systems also apply to credit-scoring systems. Here’s a brief list to help you secure a higher score:
- Try to check your credit report for accuracy before you apply for a loan. Because credit-scoring systems rely so heavily on credit report information, you’ll want to ensure that yours is correct.
- Stay current with your bill payments. Late payments can ruin your score.
- Don’t collect credit cards. Just use what you need. Credit-scoring systems frequently count credit cards, with the expectation that if you have the credit, you may eventually use it.
- Keep a safe distance from your credit limit on every credit card. High balances count against you.
- Don’t apply for substantial amounts of credit in a short period of time. Credit-scoring systems view inquiries from other creditors as an intent to charge up a storm.