subject: Does Credit Scoring Work? [print this page] The main purpose of credit scoring is to determine the reliability and credit worthiness of the borrower.
Most creditors rely on credit scores to a large extent to determine borrower credibility. But these credit report scores are frequently criticized as not being an accurate judge of consumer credit behavior.
But does credit scoring really work? This is the question that has risen time and again ever since Fair Isaac Inc. launched the FICO scores in 1989. Their use became widespread when the two mortgage underwriters Freddie Mac and Fannie Mae recommended them as a nifty tool in mortgage lending and underwriting.
The precision and reliability of credit scores has been challenged mainly because of the mystery surrounding them. A study conducted by the National Credit Reporting Association drew attention to the fact that there was no outside industry appraisal of the credit scoring method. Another interesting finding of the study was that the manner in which the variables and information in the credit bureau reports get translated into credit report scores is a well-kept secret.
And this is not only as far as the borrowers are concerned. Mortgagers, creditors, lenders and other industry regulators are also kept in the dark to an extent. This is surprising considering the amount of significance placed on credit report scores to determine the provision and pricing of credit cards, auto loans, mortgages, insurance etc. Besides, there is a remarkable lack of reviews by scholars and government regulators to ascertain whether the scoring system is just and satisfactory.
However, Fair Isaac Inc. is convinced that its credit scoring system is of immense help to creditors in deciding whether to provide credit and the rate of interest to be charged. It's also of help to consumers who are shopping for credit. Moreover, Fair Isaac claims that its model has been tried and tested time and again by numerous lenders and was found to be highly successful.
Furthermore, through statistical analysis FICO has proved that the odds of default are less with those possessing higher credit report scores. Through its graphs it has displayed that the category with credit scores of 475 or below exhibits the largest percentage of delinquency. With each increase of about 25 points along the credit score scale, the delinquency percentage drops by a proportionate rate.
While FICO scores take into consideration factors like payment history, total debt owed, utilization, kind of debt, etc., it does not consider aspects like age, salary income, occupation, child support obligations etc. These may well be important factors that influence consumer credit behavior.
Majority of creditors all across the country depend on FICO credit report scores to check past credit behavior and judge the likelihood of default.
However, there are a few who refrain from using the FICO credit scoring model. One such creditor was Golden West Financials Herb Sandler, one of the leading mortgage lenders in America. He claimed that the credit history was not conclusive enough since it was collected at a time when the economy was relatively consumer friendly. However, other creditors said that Golden West was faced with a situation different from theirs as it catered to short-run mortgages and dealt with clients personally.
Fair Isaac clearly states that its credit scores are calculated based on the credit bureau reports. Therefore, it's necessary to closely examine the credit report to understand credit scores and diminish the obscurity surrounding them.
So while most lenders claim that while credit scoring cannot say with absolute certainty whether a borrower will default, it comes very close to being an accurate judge for determining consumer credit worthiness.
