What is credit scoring?*
Information about consumers and their credit experiences, such as bill-paying histories, numbers and types of accounts, collection actions, outstanding debt, and the age of accounts, is collected from a consumer’s credit application and credit report. Using a statistical program, creditors compare this information to the credit performance of consumers with similar profiles. A credit scoring system awards points for each factor that helps predict who is most likely to repay debt. A total number of points–a credit score–helps predict how creditworthy a consumer is, that is, how likely it is that a consumer will repay a loan and make payments when due. The most popular type of credit score is usually between 300 and 850. A higher number is considered a better score.
How is a credit scoring model developed?*
A creditor selects a random sample of its customers, or a sample of similar customers if their sample is not large enough, and analyzes it statistically to identify characteristics that relate to creditworthiness. Each of these factors is assigned a weight based on how strong a predictor it is of credit risk. Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.
Under the Equal Credit Opportunity Act, a credit scoring system may not use certain characteristics like–race, sex, marital status, national origin, or religion–as factors. However, creditors are allowed to use age in properly designed scoring systems. Any scoring system that includes age must give equal or better treatment to elderly applicants.
*Reprinted with permission from National Consumer Law Center, Fair Credit Reporting, “Understanding Credit Scores” (6th ed. 2006).
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