A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual.[1] A credit score is primarily based on a credit report, information typically sourced from credit bureaus.[2]
Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits.[3] Lenders also use credit scores to determine which customers are likely to bring in the most revenue.
Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, landlords, and government departments employ the same techniques. Digital finance companies such as online lenders also use alternative data sources to calculate the creditworthiness of borrowers.[4][5]
Usage of credit scores
editCredit scores are used during all stages of the credit life cycle:
- Application scores are used to accept or reject loan requests of new customers and to price loans
- Behavioural scores are based on information about a borrower's historical behaviour
- Collection scores estimate the likelihood of a loan moving further into delinquency
- Fraud scores are used to detect potentially fraudulent activities[6]
Data sources
editTraditionally, credit scores have been based on credit data, that is, number and amount of current and past loans, delinquencies and defaults and utilisation of credit lines.
The digitalisation created or made available many more data sources which are usually referred to as alternative data. They include bank transactions, data from mobile devices, social media and utilities, as well as biometric, psychometric and web browsing data. [p 9]
The usage of alternative data sources can improve the access to credit of unbanked and underbanked customers who lack traditional credit history. However, the quality of such data may be inadequate and its use can be problematic from the consumer data protection standpoint. [p 9] The EU's lead data protection supervisor discouraged lenders from using data such as search queries and internet browsing history arguing that it "cannot be reconciled with the principles of purpose limitation, fairness and transparency."[1]
Other uses of credit scores
editIn the US credit scores are often used in determining prices for auto and homeowner's insurance.[7] US employers sometimes do credit checks on some potential employees, though they have no access to the scores themselves and to the date of birth.[8]
Regulation
editHistory
editThe statistical technique of discriminant analysis was devised by Ronald A. Fisher in 1936 and its potential application to distinguish between good and bad loans was recognised by David Durand in 1941.[pp 1-2] [2]
Before credit scores, credit was evaluated using credit reports from credit bureaus. During the late 1950s, banks started using computerized credit scoring to redefine creditworthiness as abstract statistical risk.[9]: 447
The Fair Credit Reporting Act required credit bureaus to make their data available to consumers and limited the time that the negative information could be held by credit bureaus.[p 2]
The Equal Credit Opportunity Act banned denying credit on gender or marital status in 1974, along with race, nationality, religion, age, or receipt of public assistance in 1976.[9]: 573 Credit scoring adoption accelerated to shield against discrimination lawsuits.[9]: 585
During the 1970s and 80s, the credit reporting industry relentlessly consolidated[9]: 598 and moved aggressively into prescreening.[9]: 602 The FICO score burst into public consciousness in 1995 when Freddie Mac had lenders use credit scoring for all new mortgage applications.[9]: 607
- ^ Kagan, Julia. "Credit Score". Investopedia. Archived from the original on 2007-10-19. Retrieved 2021-05-24.
- ^ "What Is a Good Credit Score?". www.experian.com. 2021-02-11. Retrieved 2021-05-24.
- ^ "What is a Credit Score – Credit Score Range | Equifax". www.equifax.com. Retrieved 2021-05-24.
- ^ Experian; Karma, Credit; Hero, Student Loan; Tretina, more Learn about our editorial policies Kat. "What Credit Score Do You Need to Buy a Car?". Investopedia. Retrieved 2021-05-24.
- ^ Kagan, Julia. "Insurance Score". Investopedia. Archived from the original on 2006-03-17. Retrieved 2021-05-24.
- ^ "CREDIT SCORING APPROACHES GUIDELINES" (PDF). The World Bank. p. 4. Retrieved 22 September 2023.
- ^ Credit-based insurance scores: Impacts on consumers of automobile insurance Archived May 11, 2009, at the Wayback Machine A Report to Congress by the Federal Trade Commission July 2007
- ^ "Can employers see your credit score? How to prepare for what they actually see when they run a credit check". CNBC. 18 July 2023. Retrieved 6 September 2023.
- ^ a b c d e f Lauer, Josh (2017). Creditworthy: A History of Consumer Surveillance and Financial Identity in America.