We all have heard of Credit Scores but how many know Why We Have Credit Scores, How They Were Created, & How They Are Used? I would say that most people have a basic idea of why we have them, but most likely very few know how they were created, and how they are used. This blog is not meant to give an in depth explanation of Why We Have Credit Scores, How They Were Created, & How They Are Used? This blog only meant to just provide a quick, basic, and simple explanation of Why We Have Credit Scores, How They Were Created, & How They Are Used? Maybe some time in the future I will go more in depth into each one of these areas, but for now I think that a basic explanation is needed more.
Before Credit Scores were established, an individual was given credit solely based on someone else's judgment and opinion. Each lender based their decision on what they personally knew about an individual, or by information that someone else provided. This worked well in smaller communities where everyone knew one another, but as communities grew this method started to prove less, and less reliable and efficient.
So over a period of time lenders started to establish a system that would assign points to different components of an individual's Credit History. This put less reliance on personal opinion, and more importance on documented information over a period of time. But this still did not completely remove a lender’s personal bias from the decision, and it was a very slow process. Lenders continued to refine this point system over time, and by the 1980’s they began to develop the Credit Models we have today. Since then most of human opinion and influence has been eliminated from the Credit Scoring Process. Score began to be generated by computers able to compute information quickly, and most of the time accurately. Because of this lenders are now able to make credit decision mainly on facts, without human bias and prejudice.
Credit scores are numbers that lenders use to help them decide if they should lend an individual money, or make credit available to them. 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 reported by Creditors to the three major Credit Bureaus, TransUnion, Equifax, and Experian.
As a borrowers credit information changes (payments, new accounts, etc.), so do their Credit Scores, how and how much their Credit Scores change depends on the “Scoring Model used. There are many different models such as a:
- Consumer Model also know as Educational Model
- Collection Model
- Bankruptcy Model
- Auto Model
- And the one that the Real Estate industry is most familiar with Mortgage Model.
Credit Scores vary based on what model is used, and sometimes even how the Credit Scores are use within each model. 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 Lenders. For example when Alt “A” products were around (no Doc, no Income, and Stated Assists), they use a modified model which was stricter than the one used for conventional loans. Alt "A" products used the lowest Credit Score to determine whether or not a borrower qualifies for one of those Loan Programs, instead of the middle Credit Score used by conventional products.
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 to try to predict how a group of individuals 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 affected by an individual's race, religion, sex (or preference), marital status, or even if the individual is on some type of government assistance. These things can not be considered in the information that makes up an individual's Credit Scores However, Lenders can take into consideration age, salary, occupation, employment history and other similar information.
Hopefully this explanation has provided a better understanding of Why We Have Credit Scores, How They Were Created, & How They Are Used?
Info about the author:
George Souto NMLS# 65149 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