Why We Have Credit Scores, How They Were Created, & How They Are Used?

By
Mortgage and Lending with George Souto NMLS #65149 FHA, CHFA, VA Mortgages NMLS #65149

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?

 

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 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 gsouto@mccuemortgage.com

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 Info about the author:

George Souto NMLS# 65149 is a Loan Originator who is licensed in #CT, #RI, #MA, #NH, & #FL and can assist you with all your #FHA, #Conventional, #VA, #USDA, and #State Bonded Progam #mortgage needs in #CT, #RI, #MA, #NH, & #FL. George resides in Middlesex County which includes #Middletown, #Old Saybrook, #Middlefield, #Durham, #Cromwell, #Portland, #Higganum, #Haddam, #East Haddam, #Moodus, #Chester, #Deep River, and #Essex. George can be contacted at (860) 573-1308 or souto@snet.net

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Re-Blogged 5 times:

Re-Blogged By Re-Blogged At
  1. Joni Bailey 06/09/2013 02:08 PM
  2. Praful Thakkar 06/09/2013 03:21 PM
  3. Brenda J. Andrew 06/09/2013 08:32 PM
  4. Nina Hollander 06/09/2013 09:15 PM
  5. Gabe Sanders 06/23/2013 09:12 PM
Topic:
Lending / Financial
Location:
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Rainmaker
4,432,467
Gita Bantwal
RE/MAX Centre Realtors - Warwick, PA
REALTOR,ABR,CRS,SRES,GRI - Bucks County & Philadel

There is a lot of misconecption about credit scores. Thanks  for the post. Suggested.

Jun 08, 2013 08:21 PM #4
Rainmaker
5,119,527
Barbara Todaro
RE/MAX Executive Realty - Franklin, MA
Marketing Agent for The Todaro Team

Good morning, George.... good job with this explanation.... I think there should be a one size fits all and applies to all credit score.... too much fluctuation and flexibility.... you either tow the mark or you get denied....maybe people would be more credit conscious and pay in a timely fashion...

Jun 08, 2013 08:31 PM #5
Rainmaker
4,160,435
Joan Cox
House to Home, Inc. - Denver Real Estate - 720-231-6373 - Denver, CO
Denver Real Estate - Selling One Home at a Time

George, It was only recently I heard there are many different credit scores, thanks for explaining this.   This is usually a question not many can answer.

Jun 08, 2013 11:25 PM #6
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George Souto
George Souto NMLS #65149 FHA, CHFA, VA Mortgages - Middletown, CT
Your Connecticut Mortgage Expert

Joe, I don't know if it is that the present system works well, or that we have just gotten use to it.

Debbie thank you for making me aware of the debt/depth.  I did mean depth, but debt was on my mind :)

Ed and Tracy thank you

Gita thank you for suggesting the blog, I appreciate that.

Barbara things did move in that direction with the elimination of subprime loans, but not far enough for one size fits all.

Joan tomorrows blog will go into the reasons for the different credit scores a little more in depth, so you might want to take a look at that one as well.

 

Jun 09, 2013 06:56 AM #7
Rainmaker
592,907
William J. Archambault, Jr.
The Real Estate Investment Institute - Houston, TX

 

George,

It’s a good post as far as it goes!

You tip-toed around the reasons, the history and the ongoing problems. This takes nothing away from his post only expands on it.

As you said under the old system "Loan Officers" made decisions. If they didn’t like you, you didn’t get the money! Discrimination happened.

In about 1970 the race questions were removed from the 1003, application form they had been in the client ID box. Less than 6 months later they were returned to the bottom of the form, but below the signature line. None of this made sense because the man (mostly) making the decision had taken the application, he knew who the applicant was!

Next came the anonymous "Loan Committee." The "Loan Committee" was no different, the Fed’s required the racial information on the 1003 and the committee saw it, they looked aat the bottom of the page, too! A few suits later and lenders looked for a better solution.

The financial crisis of 1973 saw a huge change in mortgage lending! Until then local banks and savings and Loans had dominated mortgage lending, but the Mortgage Brokers took over and dominated by the end of 1974.

Auto dealers had a 10 point credit system because dealers couldn’t be trusted to make loan decisions. Mortgage lenders longed for such a system it would end claims of discrimination and allow for automated decisions.

The Fair Isaac Company, FICO came up with a workable model, it’s arbitrary, it’s based on An The financial crisis of 1973 saw a huge change in mortgage lending! Until then local banks and savings and Loans had dominated mortgage lending, but the Mortgage Brokers took over and dominated by the end of 1974. It’s Anecdotal totally eliminating common sense in lending! But, raciest it’s not!

FICO and it’s competitors final allowed for automated mortgage lending! (I was the first broker in Nevada on line with Freddie Mac, a friendly in Vegas beat me with Fanny Mae and Gennie Mae.)

It was great calling the wholesalers and telling them I had an approved loan what would they pay for it?

There was and there remains a problem! It’s true most people with good credit histories have good FICO scores, but the many people with bad scores are very credit worthy!

To fight discrimination and for continence we and the scoring agencies have discriminated against every one who doesn’t fit the common model! Being different isn’t a protected category.

Good people with low scores fostered the "sub-prime" industry. Most "sub-prime" loans are successful, despite their higher cost and contrary to public opinion.

I’ve worked under the old system, where it was who you know and do they like you, and I’ve worked under the knew system based on who you are! I can control who I am, but can’t control who dislikes me!

I love the convince, but loath the stupify! I have a solution, allow automated approvals, but disallow automated turn-downs, require human review and allow common sense approvals.

Sorry about the length of this.

Bill

Jun 09, 2013 06:59 AM #8
Rainer
222,602
Greg Mona
Faira Homes Corp - Scottsdale, AZ
Real Estate in the 21st Century!
Thanks George. Always nice to learn something new each day, and there were some things here I wasn't aware of. Good post!
Jun 09, 2013 08:47 AM #9
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George Souto
George Souto NMLS #65149 FHA, CHFA, VA Mortgages - Middletown, CT
Your Connecticut Mortgage Expert

Bill, I have no problem with the length of your comment, there was a lot of good info and food for thought in it.  Your suggestion at the end is an interesting one that merits consideration.

Greg, glad that I could supply new information for you.

Jun 09, 2013 09:30 AM #10
Rainer
321,044
Jimmy Faulkner
Florida. Homes Realty & Mortgage - Wantagh, NY
The Best Of St. Augustine

Credit scores are essentially used to either give a loan or not give a loan and at what percentage. It really varies based on the economy & if the banks are being bullied by the government to give loans. The banks are the government so it is still very confusing. In other words it is corrupt.

Jun 09, 2013 10:26 AM #11
Rainmaker
279,186
Annette Thor
Connecticut Homes and Commercial Fairfield Cty,CT reinct.com - Westport, CT
Residential & Commercial Real Estate Broker in CT

I thought there was an average taken of the credit score, I had no idea different models were used for different products George.

Jun 09, 2013 10:39 AM #12
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George Souto
George Souto NMLS #65149 FHA, CHFA, VA Mortgages - Middletown, CT
Your Connecticut Mortgage Expert

Annette, I will be posting a blog in the morning that will explain that in a little more detail which may make it clearer for you as well.

Jun 09, 2013 11:11 AM #13
Rainmaker
1,317,601
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

George - the topic of credit scores can definitely be difficult to understand.  I just have wondered why the are 1 - 100%  You did a great job o giving an in-depth overview of credit scores.  Thanks for tackling this very complex topic.

Jun 09, 2013 11:59 AM #14
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Ed Silva
RE/MAX Professionals, CT 203-206-0754 - Waterbury, CT
Central CT Real Estate Broker Serving all equally

George, in It's a Wonderful Life, George Bailey lent money because he went to school with most of the borrowers, and then it got complicated because of Mr. Potter not wanting to loan to anyone

Jun 09, 2013 12:34 PM #15
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Joni Bailey
101 Main St. Realty - Huntsville, TX
Your Huntsville / Lake Livingston Area REALTOR®

Good Evening, George! I had no idea there were different models. Very interesting! 

Jun 09, 2013 01:09 PM #16
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Jeff Dowler, CRS
Solutions Real Estate - Carlsbad, CA
The Southern California Relocation Dude

George

This was very helpful. I really did not know about the history behind credit scores. It seems, though, that things are getting a bit complicated, with different models being used, etc.

Jeff

Jun 09, 2013 01:55 PM #17
Rainmaker
264,436
Pat & Steve Pribisko
Keller Williams Greater Cleveland West - Westlake, OH

George, this is an excellent blog on credit scoring.  Way back, between 1980 and 1983, I worked for Chemical Financial, a subsidiary of Chemical Bank of New York nka J.P. Morgan Chase.  Our closed, client files were used by Fair Isaac Co. for test marketing in its development of the FICO Scores.  Then, I had no idea that we were on the cusp of something that would be extremely important in the mortgage loan industry.

Jun 09, 2013 02:54 PM #18
Rainmaker
724,401
Wayne Johnson
Coldwell Banker D'Ann Harper REALTORS® - San Antonio, TX
San Antonio REALTOR, San Antonio Homes For Sale

George-Your blog post on credit scores, plus Bill's #8, provide a lot of good information. Thanks.

Jun 09, 2013 03:12 PM #19
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Praful Thakkar
LAER Realty Partners - Andover, MA
Andover, MA: Andover Luxury Homes For Sale

George, this is one of the best complete post I have read about credit scores! Bookmarked - for all-time reference!

Jun 09, 2013 03:19 PM #20
Rainmaker
353,936
Brenda J. Andrew
ULTIMA REAL ESTATE - Corpus Christi, TX
Professional Realtor in Corpus Christi, TX

Great information George.  I am going to re-blog this.  Thanks for sharing!

Jun 09, 2013 08:29 PM #21
Rainmaker
3,212,019
Nina Hollander
Coldwell Banker Residential Brokerage - Charlotte, NC
Your Charlotte/Ballantyne/Waxhaw/Fort Mill Realtor

George, as always a great post with lots of great information. I'm reblogging.

Jun 09, 2013 09:11 PM #22
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George Souto
George Souto NMLS #65149 FHA, CHFA, VA Mortgages - Middletown, CT
Your Connecticut Mortgage Expert

Joan glad you found the information worthy of reading.

Ed Mr Bailey and Mr. Potter, have been replaced by Mr. FICO :)

Joni glad I was able to make you aware of that.

Jeff yes it has gotten a bit complicated so maybe it is about time to simplify it again.

Pat and Steve that is a great story, you were there on the ground floor :)

Wayne my friend Bill has been around a little longer than me, so he always has valuable information to add.

Praful, thank you for the kind words, and thank you for the re-blog.

Brenda glad you found this worthy of re-blogging

Nine your re-blogs are always greatly appreciated.

Jun 10, 2013 12:55 PM #23
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