The History of the Credit Score

Credit scores became widely used in the 1980’s. Before the credit score was used, human judgment was the primary factor in deciding who received credit. Lenders relied on their past experience at observing consumer behavior as the basis for deciding which consumers warranted credit.

This was not only a slow process, but also involved human error and bias. Lenders eventually migrated away from using their own judgment to a scoring based methodology, which began to standardize how they made credit decisions.

Although such a system eliminated bias inherent using human judgment, it was not based on actual consumer behavior.

FICO Score

In 1981, the Fair Isaac Corporation introduced its credit bureau risk score. Credit bureau scores are often called “FICO scores” because the majority of credit bureau scores used in the United States are produced by software developed by the Fair Isaac Corporation.

The Fair Isaac Corporation was founded in the 1950’s and over the years, has developed its credit scoring methodology based on statistical models that utilize consumer behavior to rate credit risk. These models were built using payment information from thousands of actual consumers.

Designers of credit scoring models review a set of consumers, often over a million, who opened loans at the same time, and determine who paid their loan and who did not. The credit profiles of the consumers who defaulted on the loans are examined to identify common variables they exhibited at the time they applied for the loan. Such variables are combined to create a credit score.

Models for specific types of loans, such as auto or home, more closely consider consumer payment statistics related to these loans. Model builders aim to identify the optimum set of variables from a consumer’s past credit history that will most effectively predict future credit behavior. Statistical models are continuously being refined to better predict consumer behavior.

Credit Reporting Agencies

Credit risk scores are provided to lenders by the three major credit reporting agencies. The three major credit reporting agencies, Equifax, Experian and TransUnion. have different names for their FICO scores. All FICO scores, regardless of the agency, however, are developed using the methodology developed by Fair Isaac Corporation as shown below:

Experian, Equifax and TransUnion, each has its own consumer database and different criteria for scoring credit. Data about individual consumers can vary depending on the agency.

Experian is the youngest agency and specializes in providing businesses with credit-worthy leads for purposes of direct mailing; TransUnion is known for keeping track of foreign creditors and the credit of Americans abroad while Equifax, the oldest, began by keeping track of corporate credit.

Since their introduction, FICO scores were used by banks, auto lenders, insurance and credit card companies, and they gained notable prominence in 1995 when Fannie Mae and Freddie Mac recommend the use of FICO scores for evaluating US mortgage loans. During the housing boom, banks made large credit decisions based on these FICO scores.

FICO Score Range

A FICO score ranges between 300 and 850; each major credit reporting agency may have slight variations of this range but their respective FICO scores will fall within this range. Normally, the higher the score, the less of a credit risk you are, and a good credit score generally starts with a 7.

Although the FICO score has in the past had a monopoly in the credit scoring market, VantageScore, one of FICO’s main competitors, has been working with the three major credit bureaus, Equifax, Experian, and TransUnion, to develop a competitive credit scoring model.

In the VantageScore scoring model, credit scores range between 501 and 990. In fact, in May of 2010, the U.S. Patent and Trademark Office was ordered by a District Court judge to cancel Fair Isaac’s “300-850” trademark. Such a development could pave the way for additional competition and perhaps increase access to credit for consumers who are either “underbanked” or deemed “unscoreable” using other credit scoring models.