Introducing The FICO Score
The process of credit scoring is carried out primarily by specialized companies called Credit Reporting Agencies (CRAs). These agencies have access to a large amount of private financial information, which they use to arrive at a singular number. The FICO score, which is by far the most widely used credit-scoring instrument, was developed in the late 1950s by a man named Bill Fair and a mathematician named Earl Isaac. They both established a company called the Fair Isaac Corporation whose primary business was to provide lending institutions an insight into their corporation. For almost half a century, this information was kept away from customers under the pretext that revealing a customer’s FICO score would be of little value of their financial planning. In 2000, however, a landmark congressional ruling paved the way for public access to FICO scores. There are three variants of the FICO score developed by three major CRAs: Experian, Equifax and TransUnion. Your score may vary from CRA to CRA. Recently, however, all three CRAs collaborated to produce a consolidated credit score called VantageScore and this metric has started to become the standard.
History Of Credit Scoring
Bill Fair and Earl Isaac established the Fair Isaac Corporation for the simple reason that there was a tremendous need among financial institutions to ensure that the people they were giving credit to had the financial capability to pay their money back. Bankruptcy laws often left creditors in the dust. The FICO score, therefore, was developed to be a metric that looked at a potential customer’s full financial history and mathematically calculated the probability that he or she would pay the loan back on time. In the 1950s, however, Bill Fair and Earl Isaac did not have enough data to work on. The biggest achievement of the FICO score, therefore, is the introduction of a system that meticulously keeps records of each financial transaction and facilitates the easy transfer of information between like-minded financial institutions, a system that took more than twenty years to be fully functional! Since 1958, when data collection for the FICO system formally began, the world has become more networked and companies like FICO have the Internet and other related technologies to collect information. The result is an incredibly accurate score that is rarely wrong.
Use of Credit Scoring Beyond Lending
Financial institutions use credit scoring primarily to ascertain whether or not you as a customer are in a position to repay the loan within the stipulated time period. There are, however, a few other uses for the credit score. Firstly, because credit scores take your entire financial history into account and meticulously crunch numbers to arrive at a conclusive rating, they offer Americans an incredible amount of insight into their spending habits and financial health in general. Even if you are not interested in taking a loan or buying something on credit, knowing your credit score and reading your longer, more comprehensive credit report can help you figure out where you need to improve on financially. You may be overspending in certain areas or taking unnecessary financial risks in another. A credit score can help you figure out what’s right and what’s wrong with the way you handle money. Another up and coming use for credit scoring is to determine insurance premiums. Studies have positively correlated high credit scores with fewer claims so a number of insurance companies now use credit scores to determine, among other things, what your premium should be and what the terms of your insurance include.