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Credit Scoring - What You Don't Know Can't Hurt You
Credit scoring has been widely used outside of credit card applications (not to mention in other parts of the credit cycle) for well over a decade, but has not been used widely for mortgages or featured in an ordinary credit report until the past few years. Now Fannie Mae and Freddie Mac (Federal Agencies with vast influence over lending policies) have decreed that all mortgages with federal connections in the United States must use credit scoring to evaluate applicants by late 1996.
Many thanks to Roger Lustig, who provided the information for this page.
What is credit scoring?
The credit scoring procedure is an automated evaluation
tool used to evaluate both credit applications AND risk in existing credit lines. It's also used for many other purposes, including marketing and
collections. Although this procedure is almost never explained to applicants, rejected applicants must be supplied with reasons for declination. If these have been derived from a
score, the specific variables that led to rejection must be disclosed.
(return to Index)
Is credit scoring a new concept?
Credit Scoring is not a new concept. One man who wrote to us, Roger Lustig, stated that he's personally been involved in credit scoring for over twelve years, consumer loans, finance companies, etc. As a matter of fact, some credit grantors have gone so far as to allow applicants to score themselves. Strawbridge and Clothier in Philadelphia did this for years, and may still do so.
There are strict rules and regulations governing what can and can not be scored; Regulation B of the Equal Credit Opportunity Act regulates precisely that, and further specifies how certain variables may be used. The FTC has won many cases against lenders for illegal or improper scoring models. (return to Index)
How does credit scoring supposedly work?
Fair Isaac, Inc. pioneered credit scoring. Your daily transactions are followed by computers at "service provider" centers. The ongoing evaluation process looks at credit balances, purchases and address and job changes, but most include such usual items as credit card purchases, late payments and debt ratios. Credit scoring has not failed; scores that do not predict in valid, legal ways are not only unprofitable but actionable, and many have been removed for those very reasons.
Hardly any credit scoring, and *no* credit scoring at the application
level, is based on daily transactions. For new applications, this is
simply impossible, as the recipient of the application has no data source. For
behavior scoring of existing accounts, the benefits do not justify the
cost of processing.
(return to Index)
What has our Government done to protect us?
- The Fair Credit Reporting Act has been amended frequently, and its
regulatory requirements toughened.
- the Equal Credit Opportunity Act and its regulations provide a
framework for scoring.
- Congress has provided a great deal of new regulation, including the
opportunity for any individual to examine their credit report for free
once a year, in recent years, In fact, free looks at one's credit report have been mandatory since the
late 1970's for anyone denied credit. FTC Press Release
- they have the right to know why they were denied credit, and have
the right to appeal if any inaccurate information was used in the decision.
Because of the long-standing "free look" rule, the consumer may get all
relevant information for the appeal.
- ALL consumers MUST be allowed to appeal the use of inaccurate
information, and may file suit if they consider the evaluation
process to have been illegally discriminatory or statistically
invalid, and such information must be divulged in the discovery phase of
any lawsuit.
To remove erroneous information on a credit report, consumers must challenge their credit reports as described in Fixing your credit report. (return to Index)
Is the decision to grant me credit made by a machine?
All credit denials are made by humans, based on their own judgment of an applicant ability/willingness to pay and his-or-her's past credit history. Credit scoring merely sums up all the available data quickly, and in an easy to digest way. Besides, humans installed the algorithms to make the decisions. Suffice
it to say that computers do not discriminate along racial, gender, gender-preference, ethnic, or other prohibited lines the way humans might; moreover, the existence of algorithms, along with the regulation
of their content, ensures that the "computer-made" decisions are not in violation of equal-opportunity and anti-discrimination laws.
Simply stated, Computers are used to process information according to (human-made) decision algorithms, but they do not make the decisions. (return to Index)
How can we protect ourselves?
All consumers can, and should, request a credit report from each of the major agencies annually, and update or correct all inaccuracies, errors, and other problems.
America has the most efficient, easily used measures against incorrect reporting. It also has carefully enforced laws against improper use of the credit bureau report. all adverse actions by a creditor must be explained, and full disclosure of reasons for the decision given, and appeals
must be allowed and considered in good faith. (return to Index)
Do you have a question we haven't answered? Call us! E-mail us! or Buy the Book!
Document last modified Monday, 02-Feb-2004 12:30:28 EST
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