Credit Scoring
Have you ever wondered how a creditor decides whether to grant you credit? For years, creditors have been using systems of credit scoring to determine if you’d be a good risk for credit cards and auto loans. More recently, credit scoring has been used to help creditors evaluate your ability to repay home mortgage loans. This is how credit scoring works in helping decide who gets approved for credit and who doesn’t.
What is credit scoring?
Creditors, to help determine whether to give you credit, use credit scoring systems. Your personal information and your credit experiences, such as your bill-paying history, the number and type of accounts you have, late payments, collection actions, outstanding debt, and the age of your accounts, is collected from your credit application and your credit report. Using a statistical program, creditors compare this information to the credit performance of consumers with similar profiles. A credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points — a credit score or — helps predict your worthiness to receive credit, that is, how likely it is that you will repay a loan and make the payments when due. Because your credit report is an important part of many credit scoring systems, it is very important to make sure it’s accurate before you submit a credit application.
The consumer credit report contains four basic types of data.
- Your identity and employment information. This includes such basic information as your name, date of birth, social, employer and marital status. Information on employment history, income and home ownership may also be included.
- Your existing credit and repayment record will also be contained in the report. This will show how much you have borrowed and if you pay on time.
- A list of all enquiries made on your account will also be stored. Consumer reporting companies are required to store this information.
- Public or legal events such as bankruptcies and tax liens will also be included.
Why is credit scoring used?
Credit scoring is based on data and statistics, so it usually is more reliable than subjective or judgmental methods. It treats all applicants objectively. Judgmental methods typically rely on criteria that are not systematically tested and can vary when applied by different individuals.
How is a credit scoring model developed?
To assess your score, 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.
