I have read a number of Posts here on ActiveRain on Credit and Credit Scores, and I have written Posts on this same topic myself. All of the Post that I have read or written provided good information on how to improve your Credit, or on what effects your Credit Scores. But I have not seen any Posts on “where Credit Scores came from, what they are, and why we have them”. So I will attempt in this Post to begin to do that.
Before Credit Scores were established, a person was given credit solely based on another human being’s judgment and opinion. Each lender based their decision on what they knew about a particular person from their personal experience, or by information that someone else provided them with. This was not a very good or accurate way of making such an important decision.
So over a period of time lenders started to establish a system that would assign points to different components of a person’s Credit History. By doing this, a lot of the personal opinion was removed from deciding who a lender would give credit to, and who they would not. But this still did not completely remove a lender’s personal bias from the decision, and it was still a very slow process. Lenders continued to refine this point system, and by the 1980’s they began to develop the different Credit Models that are in place today. Since then much of the human influence was eliminated from the Credit Scoring Process. Score began to be generated by computers that were able to compute information accurately, and very quickly. Because of this lenders are now able to make credit decision solely on facts, without human prejudice involved in their decision.
First lets start with what are Credit Scores? Credit scores are numbers that lenders use to help them decide if they should lend a person money or make credit available to them, and how likely is it that they will pay it back. Credit scores are sometimes also referred to as “Risk Scores” because they represent the level of risk that a borrower will repay the money borrowed in the manor and time that it was agreed upon. Credit Scores are generated through statistical models which use information that has been collected on a person’s credit report. These scores are produced when a lender pulls credit on a borrower, and they are included with the borrowers credit history. However, the scores are not made a part of the borrowers credit history, because they only represent a snap shot of that moment in time.
As a borrowers credit information changes (payments, new accounts, etc.), so does their Credit Score, how and how much a Credit Score changes depends on the “Scoring Model that is used. There are many different models Consumer Models also know as Educational Models, Collection Models, Bankruptcy Models, Auto Models, and the one that the Real Estate industry ia most familiar with Mortgage Models. Credit Scores vary based on what model is used, and even sometimes within these models. For example most Mortgage Companies and Banks will use a borrowers middle score to determining their credit worthiness and level of risk. However, some have modified the Mortgage Model to fit certain criteria that is more important to them then to another Mortgage Lender. For example this is the case with our Alt “A” products, they use a modified model which is stricter than the one we use for conventional loans. So in there case we use the lowest Credit Score to determine whether or not a borrower qualifies for one of those Loan Programs.
These Credit Score Models are developed by looking at the credit history of hundreds of thousands of borrowers to determine common traits and patterns. With this information Credit Score Models are then created by using this information to try to predict how a group of people with similar traits and behaviors will behave in the future. By doing this they can develop models that will place different weights and values on certain criteria which has more or less impact on that particular industry.
Credit Scores are not effected by a person’s race, religion, sex (or preference), marital status, or even if the person is on some type of government assistance. These things can not be considered in the information that makes up a person’s Credit Score. However, lenders can take into consideration age, salary, occupation, employment history and other similar information.
Next week I will try to further explain what happens once information is collected and applied to these different Credit Models, as well as why Credit Scores vary among the three major Credit Reporting Agencies in the US, Equifax, Experian, and TransUnion. Stay tuned for more.
Info about the author:
George Souto is a Loan Officer who can assist you with all your FHA, CHFA, and Conventional mortgage needs in Connecticut. George resides in Middlesex County which includes Middletown, Middlefield, Durham, Cromwell, Portland, Higganum, Haddam, East Haddam, Chester, Deep River, and Essex. George can be contacted at (860) 573-1308 or firstname.lastname@example.org