June 28, 2022
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My Credit Score

My Credit Score

A credit score is a number representing the creditworthiness of a person; that is, the likelihood that a person will pay his or her debts.  In the United States, the best-known and most likely used credit score model is the FICO score, calculated statistically with information drawn from a consumer’s credit files.

In the 1960s, the federal government started investigating discriminatory practices alleged to exist in the granting of housing loans.  In the late 1970s, the Fair Isacc Company, now referred to as FICO, started working on a mathematical formula for rating a person’s credit based upon his or her previous transactions.  Coming up with what was considered a reliable form based upon only the person’s previous habits, they released the information in the early 1980s and it was picked as the “standard.”  At the time, the government was desperate for a uniform, standardized, unbiased way that credit loans could be decided without discrimination. FICO fit the bill.  The FICO score was not foolproof but the timing of the release fit in with the latest computer programs that were being designed at that time.

FICO discloses the following information:

35% – payment history

30% – credit utilization

15% – length of credit history

10% – types of credit used

10% – recent search for credit

FICO scores may fall between 300 and 850. While exhibiting a left-skewed distribution, it is notable that 60% of the scores on the right side of the distribution are between 650 and 799.  According to FICO the median score is 723.

Each individual FICO score is determined by credit scores arrived at by the analysis of three national credit bureaus, Experian, Equifax, and TransUnion.  Given this, data about individual consumers can vary from bureau to bureau.

At a practical level, credit scores are often used in determining prices for auto and homeowner’s insurance.  Starting in the 1990s, the national credit reporting agencies that generate credit scores have also been generating more specialized insurance scores, which insurance companies then use to rate the insurance risk of potential customers.

Today, it seems that there are more than 50 million Americans who do not have enough credit usage to qualify for most commonly used credit scores.  Although credit scoring is considered to be a good system of rating a person’s reliability with money, it is still a system with many glitches and delays.  The math that is used to calculate your credit score can also be devastating to your credit rating if the information it is based on is wrong.  Unfortunately, most credit reports are riddle with errors.  Usually the errors are small such as misspellings of employer names; but at other times, problem may be huge, such as the case when your credit file contains delinquent records that do not belong to you.

Financial experts say that the main problem with FICO scores is that the formula that creates them is too complex.  This creates an unpredictable model that makes it hard to forecast what the credit score might end up being.  In fact, it is not uncommon at all for two different lenders to calculate the FICO score for an applicant using identical information and ultimately arrive at two completely different numbers.  The entire point of developing a system that described people in financial situations using a number was that it was supposed to have nothing to do with your race, income, religion, ethnic background, disability or anything else that is not usually detailed in a credit report.

Given all the potential problems with credit scoring, it is understandable that some people will think the system is fatally flawed.  However, flawed or not, credit scoring is a necessity for the world to go round. Just like death and taxes, most of us need credit to launch a new business, pay for a home, or go to school.

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Written by
Donald Wittmer

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