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The History of Credit Scores

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September 8, 2022 | Jonathan Pryer

When were credit scores invented and how does credit scoring work?

We hear the term credit scores and credit reports thrown around frequently when it comes to financial services products. But when were credit scores invented, and how does consumer credit reporting work? We’ve got your no-nonsense guide to all things credit scores. Read on to learn:

Credit Scores and Credit Bureaus: An Origin Story

Credit scores as we know them today have only been around for a few decades. However, credit reporting itself began early in the 19th century, as commercial lenders attempted to ‘score’ potential business customers to determine the risk in providing credit to them. The very first credit reporting agencies (what we know now as companies like TransUnion and Equifax), began as local merchant associations. They simply collected various financial and identification information about potential borrowers and then sold it to lenders – but these were focused strictly on commercial/business loans at the start, offered to organizations that needed funding to launch or grow their operations. The earliest credit reporting agencies in the United States were R.G. Dun & Co and the Bradstreet Company (sidenote: sound familiar? The two companies merged in 1933 and rebranded as Dun & Bradstreet Inc. in 1939), which developed an alphanumeric scoring method to determine the risk factors associated with commercial loan applications.

In the early 20th century, modern credit bureaus were formed, looking more closely like we know them today. Taking a page out of the commercial-loans book, retailers began offering consumer credit to individuals. These retailers all had individual credit managers, tasked with determining creditworthiness of applicants. In 1912, they decided to band together and formed a national association to “develop a standard method for collecting, sharing and codifying information on retail debtors.”

In subsequent years, the three major credit bureaus in the U.S. were born – today known as Equifax, TransUnion, and Experian. Through the 70s and 80s they worked together to develop consistencies in credit reporting methods and pushed for an unbiased, more automated way of determining credit scores.

Credit Score Vs. Credit Report

But what IS a credit score? And how is it calculated? And what’s the difference between a credit score and a credit report?

A credit report comes first. A detailed historical record of your financial transactions and financial status, a credit report includes everything from identifying personal information (name, address, date of birth), to consumer credit accounts (credit cards, lines of credit, auto loans, mortgages), and ‘inquiry’ information (i.e., information on the companies who have pulled your credit report to make you offers of new credit products, or pre-approvals for upsells, etc.). A credit score is then calculated based on that information. Typically a three digit number (we’ll get into regional differences later), this credit score quickly tells potential lenders how creditworthy you are. In North America, the higher the score, the lower risk you are and therefore, a more worthy applicant.

Traditional credit scoring systems are not without fault, however. They often don’t take into consideration additional factors that can influence your credit risk level (i.e., most modern credit reports don’t include rental payments, which can be a very accurate predictor of someone’s propensity to pay back debt.) And there can be a significant lag between an applicant’s activities and pulling a credit report/score – real-time data is much more valuable (and accurate) in assessing an individual’s risk.

So how do credit scores really work? A mathematical formula based on the information found in your detailed credit report, a credit score allows potential lenders to instantly assess how creditworthy you are. A higher credit score indicates that a) you are more likely to pay off your debt/repay any credit provided and b) pay off that debt both on time, and according to the agreed-upon terms. With a more favorable credit score, you are more likely to have lenders extend you credit products, such as new credit cards, auto loans, mortgages, and consumer loans. Beyond that, the higher your credit score, the more likely it is that lenders will offer you better terms, including flexible repayment schedules and lower interest rates. If you are stuck carrying a low credit score, you run the risk of not being able to access credit when you need it or having to accept higher interest rates.

Calculating Your Credit Score

A FICO score (Fair, Issac and Company) is one of the most well-known credit scores in the US. In fact, “FICO scores are used by 90% of the top US lending institutions for their risk assessment needs.” These three-digit scores, which first began in 1989, are calculated based on the information found in your credit report from one of the three major credit bureaus. There are five main factors that FICO uses to calculate your credit score, with different categories carrying different weights. (Sidenote: other credit scores are calculated much the same way but may have different weights associated with the main contributing factors.)

For FICO scores, the factors are:

  • Payment history (35%)
  • Balances owed/credit usage (30%)
  • Length of credit history/age of accounts (15%)
  • Credit mix (10%)
  • Recent credit activity and new accounts/new credit inquiries (10%)

Credit Scoring Around the World

Despite the overwhelming prominence of the United States’ three main credit bureaus, there are regional differences in credit scoring models and the use of credit scores. While each region uses the same basic premise of evaluating an individual’s credit history to determine their creditworthiness, there are variations in how that credit scoring is executed. The main variations in credit scoring methods relate to:

  • How long certain information stays on your credit report
  • Who can contribute information to your credit report
  • How many credit bureaus exist in a particular country/region
  • Whether those credit bureaus are for-profit or not-for-profit (and who owns them)
  • Whether lenders are required to use your credit report and/or credit score to determine your risk level

Here’s a handful of examples of the ways various regions handle credit scoring:

  • United States – Lenders report details of your financial situation, including credit and historical transactions, to one of the three major credit bureaus (Equifax, Experian and TransUnion) – who then either generate a credit score or provide the credit reports to a credit scoring company like FICO, which then calculates a FICO score.
  • Canada – Canada is similar to the U.S, but doesn’t use Experian as a credit bureau, and its credit scores upper limit is 900 vs 850.
  • United Kingdom – The U.K. has three major credit agencies – Equifax, Experian and Callcredit (Noddle), but each organization calculates credit scores differently.
  • France – There are no official credit reporting agencies in France; instead, credit scores are built on a bank-by-bank basis but aren’t transferable to other lending institutions.
  • Netherlands – The Netherlands has a single credit bureau, Krediet Registratie (BKR), which unpaid debts are reported to.
  • Germany – The main credit agency, SCHUFA, is a private company that tracks accounts, unpaid debts, loans, and any delinquencies. Your SCHUFA score goes down (which is positive) as you gain financial history and pay down debts.
  • Australia – Australia has four main credit bureaus (Equifax, Dun and Bradstreet, Experian, and the Tasmanian Collection Service).
  • India – India utilizes one official credit reporting agency, Credit Bureau Information India (CIBIL), which is a partner of TransUnion.
  • Japan – There is no official credit scoring system in Japan, and creditworthiness is simply determined by individual lenders, making it extremely difficult to get credit if you are a foreigner.

How does credit scoring affect consumer lending?

A credit score that is rated as ‘good’ or ‘excellent’ will save most people thousands of dollars over the course of their lifetime. If you have excellent credit, you get better rates and payment terms on everything from mortgages and auto loans to credit cards and lines of credit – essentially anything that requires any sort of financing. If you have a better credit rating, you are seen as a lower-risk borrower, with more banks and lenders readily competing for your business by offering better rates, fees, and perks. On the flipside, those with poor credit ratings are seen as higher-risk borrowers, and may either have less favorable lending terms (higher interest rates in particular), or be unable to access credit at all when they need. Apart from just accessing lending products, those with poor credit scores may find it difficult to find rental housing, rent a car or even obtain life insurance.

Lenders use credit scores as part of their risk decisioning process to determine the creditworthiness of a potential individual or business customer. So, the ripple effect of either a positive or negative credit score is significant – and it can last an incredibly long time, particularly if there are delinquencies or defaults noted on your credit report. 

However, part of the issue with this is that credit scoring can often have inherent biases. This greatly impacts various demographics from fairly accessing credit. For example, immigrant communities may not have formal credit histories. No credit history = low credit score. Low credit score means they can’t easily access lending products and therefore can’t start building a credit report/score. Or they are forced to accept suboptimal terms with exorbitantly high interest rates and may have difficultly paying down that debt as a result. Which of course, is a mark against you on your credit report.

Alternative Data for Financial Inclusion

The example above is not uncommon in our global society – there are countless immigrant populations in countries all over the world, and millions more who have no access to formal financial services products. There are many terms for those who lack a traditional credit history – thin-filed, credit invisible, unbanked, underbanked – but it essentially refers to anyone who doesn’t have information in their official credit history/report to generate a credit score. This includes an estimated 62 million Americans, 200 million people in Latin America and 3.6 million in Asia having no access to formal credit. One-third of all adults globally (up to 1.7 billion people) lack any type of bank account.

How can lenders ensure equal access to credit, even for those without formal credit histories, without sacrificing their risk strategy? One way is to use alternative data. Alternative data includes anything outside of a traditional credit report that may indicate creditworthiness, including telco information, rent and utilities payment info, social media and web presence, travel data and open banking info.

Because this type of data is often missing from traditional credit reports (and thus the formulation of credit scores), they can be inherently biased towards certain minority demographics. The data that FICO scores consider (like payment history, length of credit history, etc.) is also often influenced by generational wealth and the passing of large assets like homeownership (i.e., mortgage data counts towards your credit score, rental payment usually does not). “The Black homeownership rate was 44% at the end of 2020 compared to the 74.5% rate for non-Hispanic white consumers. Since credit scoring models look at homeowners’ housing payments and ignore renters’ rental payment history, Black consumers are at another disadvantage, despite both types of payments falling under the same category of “housing.” Ensuring that lenders are supplementing traditional credit scores with alternative data helps to overcome that bias and ensures financial inclusion.

Using alternative data helps to provide a more holistic view of the financial health (both current and future potential) of customers, improves decisioning accuracy and even helps increase fraud protection with improved identity verification and KYC processes. Enabling more accurate credit decisioning allows lenders to expand their market safely, without increasing risk, and helps to encourage access to all unbanked/thin-filed individuals, setting people on the path to safely building their credit scores. Eighty-seven percent of lenders using alternative data are using it to more accurately evaluate thin/no-file customers and 64% improve their risk assessment among unbanked consumers.

Apart from individual lenders looking to alternative data sources, some credit bureaus are now offering ways to boost credit scores for thin-filed consumers:

  • Experian Boost – collects financial information that isn’t normally found in your credit report (i.e., utility payments and banking history) and includes that in the calculation of your Experian FICO score.
  • UltraFICO – free program that utilizes historical banking information to build your FICO score, looking at factors like paying bills on time, avoiding overdraft, and having savings.
  • Rental info reporting – new services that track rental payments and report that info to credit bureaus on your behalf.

How to improve your credit score

If you are struggling with a less than ideal credit score, don’t fret. There are steps you can take to improve your score over time:

  • Pay your bills on time, every time. This includes everything from mortgage payments and car loans to credit cards, utility bills and cell phone plans.
  • Reduce your overall credit utilization. Credit scores look at your credit utilization (the portion of your available credit that you use at any given time). After payment history, credit utilization is the second more important factor when calculating your credit score. Aim for 30% credit utilization or less to keep your credit score favorable and try to pay off credit card balances in full each month. (Bonus tip for a quick win – ask your credit card issuers to increase your limit slightly so your debt ratio goes down.)
  • Don’t apply for too much credit. New credit requests start with a ‘hard inquiry’ (hard inquiries include applications for new credit cards, mortgages, auto loans – too many of them can increase your credit score). Revolving credit (regularly closing old accounts and opening new ones) also has a negative impact on your credit score. Additionally, credit scores look at how long you’ve had your credit accounts – keep your old accounts open and old credit cards active but be sure to deal with any collections or delinquent accounts. If you have a lot of outstanding debt over various types of accounts, consider consolidating your loans, which results in one repayment, and possibly a lower interest rate to boot.
  • Sign up for credit monitoring services. These services can alert you to fraudulent behavior on your profile, help you keep up to date on your credit score, and often offer special tips on how to improve your credit score.

It’s clear that credit reports and credit scores have a significant impact on your ability to access credit. But as the financial services industry evolves, there are more and more innovative ways to determine creditworthiness, including the integration of alternative data, implementation of advanced decisioning solutions, and using more accurate, predictive models with artificial intelligence. And there are now more varied opportunities to access credit and financial services products, including the advancement of buy now, pay later (BNPL) solutions, and neobanks and fintechs who are taking a fresh approach to credit products.

If you’re a lender, how can you ensure that the history of credit scoring continues to evolve into something more holistic, more accurate, and more inclusive? Discover how a unified decisioning platform and easy access to a variety of data sources can help you say yes to more people, without increasing your risk.

Further Reading:

15 Companies Changing the Landscape of BNPL: https://www.provenir.com/resources/blog/15-companies-changing-the-landscape-of-buy-now-pay-later/

The Long, Twisted History of Your Credit Score – Time Magazine: https://time.com/3961676/history-credit-scores/

A History of Credit Scores – point.app: https://www.point.app/article/a-history-of-credit-scores-when-did-they-become-a-thing

The Fair Credit Reporting Act (FCRA) – Investopedia: https://www.investopedia.com/terms/f/fair-credit-reporting-act-fcra.asp

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