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FICO Credit Score Reporting

FICO Credit Score Reporting

History of FICO Credit Score Reporting

FICO Credit score reporting was non- existent when credit cards first began to appear in the 1950’s.   Extension of credit and lending (making of loans) at the time were almost entirely subjective.  For the most part a lender or credit analyst followed their own judgments when granting or denying loan or credit requests, a process that required days or weeks.  Lending institutions of the day such as banks and other financial institutions tended to be locally based and decisions were likely to be made on a personal basis.  This arrangement on one hand put lenders at risk of customers defaulting on their payments.  On the other hand, lenders tended to be overly conservative, and discrimination based on age, sex, marital status, and ethnicity was rampant, making credit unavailable to many.

FICO gets its beginning

During the the 1950s, FICO credit score reporting although unheard of got its beginning when two men William R. Fair, a mathematician with degrees from the California Institution of Technology, Stanford University, and the University of California at Berkeley, began investigating mathematical techniques for use in building models of predictive behavior. Fair was attracted to the relatively unrecognized complexity involved in the credit decision process, finding that the variables typically used in determining credit could produce trillions of possible combinations. Fair determined, however, that by using statistical techniques, such as multivariate analysis to produce scoring algorithms, this complexity could be greatly reduced. Furthermore, recent advances in computer technology, especially the introduction of transistors, allowed calculations to be automated and processed quickly. Joined by Earl Isaac, an electrical engineer, Fair started up a management consultant companyas a 50-50 joint venture in 1956. As Rosenberger told Investor’s Business Daily, “Some firms are founded to create wealth, but this firm was born in 1956 from a desire to do things the partners liked to do.”

Fair, Isaac introduced the first credit reporting system

In 1958, Fair, Isaac introduced their first credit reporting scoring system, called Credit Application Scoring Algorithms, proving that their system could accurately predict the payment behavior of credit holders, including whether they would pay on time, pay late, or not pay at all. Two years later, Fair, Isaac launched the first version of the company’s INFORM product, a process for building scoring algorithms based on a customer’s database of past borrowing behavior. In that year, the pair incorporated the company as Fair, Isaac and Company.

Creditors slow to adopt credit scoring

Credit lenders were slow to adopt any credit score reporting partially due to technology .  We have moved a long way from then when computer anything was not quickly accepted in part because of the slow penetration of computer technology into mainstream commercial use, clinging to traditional judgment-based decision-making methods and relying on credit bureaus, which reported on an individual’s past credit behavior. Fair, Isaac received a boost, however, when the Internal Revenue Service (IRS) contracted the company to develop a scoring algorithm that would enable the IRS to locate tax evaders more accurately. That system, put into place in 1972, quickly produced results: The number of audits dropped by a third, and the IRS posted a higher level of uncovered underpayments. During the 1960s, Fair, Isaac attempted to extend their scoring system to employee hiring practices; although this attempt forecasted the flexibility of scoring, the company found little enthusiasm among businesses for such a system. At the end of the decade, however, Fair, Isaac moved to extend credit scoring, beginning research on a behavior scoring system for monitoring credit purchases and payments.

Credit Reporting scoring breakthrough

History now tells us credit score reporting  witnessed a breakthrough era in the  1970s .  The introduction of faster minicomputers led more credit companies to add credit scoring to their application process. In 1972, Fair, Isaac adapted its products for use with minicomputers, allowing credit applications to become fully automated. Credit scoring was also proving flexible enough to meet the variety of lenders’ needs. Using data gathered from a lender’s own database, credit scoring allowed the lender to build predictive models, and acceptance levels, based on criteria specific to the lender, its customers, and their region. Credit scoring had another advantage in that it was completely objective and non-discrimatory  factors such as a person’s age, sex, or race held no place in a credit reporting scoring. Indeed, Fair, Isaac worked hard and has proven that these factors held no predictive value in determining an individual’s creditworthiness. Lenders were reluctant to set aside their prejudices, however. In 1974, however, they were forced to do so with the passage of the Equal Credit Opportunity Act, which barred such discriminatory factors from the credit equation.

Factors determining FICO Credit Reporting

Credit score reporting algorithms are complicated and FICO keeps theme confidential but FICO credit scores are designed to measure the risk of default by taking into account various factors in a person’s financial history. Although the exact formulas for calculating credit scores are secret, FICO has disclosed the following components:

  • 35%: payment history: This is best described as the presence or lack of derogatory information. Bankruptcy, liens, judgments, settlements, charge offs, repossessions, foreclosures, and late payments can cause a FICO score to drop.
  • 30%: debt burden: This category considers a number of debt specific measurements, and not just the infamous credit card debt to limit ratio, as is commonly misreported. According to FICO there are some six different metrics in the debt category including the debt to limit ratio, number of accounts with balances, amount owed across different types of accounts, and the amount paid down on installment loans.
  • 15%: length of credit history aka Time in File: As a credit history ages it can have a positive impact on its FICO score. There are two metrics in this category: the average age of the accounts on your report and the age of the oldest account.
  • 10%: types of credit used (installment, revolving, consumer finance, mortgage): Consumers can benefit by having a history of managing different types of credit.
  • 10%: recent searches for credit: hard credit inquiries, which occur when consumers apply for a credit card or loan (revolving or otherwise), can hurt scores, especially if done in great numbers. Individuals who are “rate shopping” for a mortgage, auto loan, or student loan over a short period (two weeks or 45 days, depending on the generation of FICO score used) will likely not experience a meaningful decrease in their scores as a result of these types of inquiries, as the FICO scoring model considers all of those types of hard inquiries that occur within 14 or 45 days of each other as only one. Further, mortgage, auto, and student loan inquiries do not count at all in your FICO score if they are less than 30 days old. While all credit inquiries are recorded and displayed on personal credit reports for two years they have no effect after the first year because FICO’s scoring system ignores them after 12 months. Credit inquiries that were made by the consumer (such as pulling a credit report for personal use), by an employer (for employee verification), or by companies initiating pre-screened offers of credit or insurance do not have any impact on a credit score: these are called “soft inquiries” or “soft pulls”, and do not appear on a credit report used by lenders, only on personal reports. Soft inquires are not considered by credit scoring systems.

Getting a higher credit limit can help your credit score. The higher the credit limit on the credit card, the lower the utilization ratio average for all of your credit card accounts. The utilization ratio is the amount owed divided by the amount extended by the creditor and the lower it is the better your FICO rating, in general. So if you have one credit card with a used balance of $500 and a limit of $1,000 as well as another with a used balance of $700 and $2,000 limit; the average ratio is 40 percent ($1,200 total used divided by $3,000 total limits). If the first credit card company raises the limit to $2,000; the ratio lowers to 30 percent; which could boost the FICO rating.

There are other special factors which can weigh on the FICO score.

  • Any money owed because of a court judgment, tax lien, etc., carries an additional negative penalty, especially when recent.
  • Having one or more newly opened consumer finance credit accounts may also be a negative

FICO Credit Reporting Impact on Home Ownership

There is one common American Dream at the core of our great country is the dream of home ownership.  Credit score reporting absolutely is probably the most important to owning a home.  Credit Reporting scores from FICO range from 350-800 and generally speaking 580-619 poor, 620-680 good, 680-800 Excellent.  The better the FICO credit scores can often be a determining factor for approval or denial but also the rate of interest a borrower will pay.  Knowing what FICO credit reporting is and the impact on home ownership can become a tool for personal advancement.  Financial discipline can be crucial to success or failure of the American Dream of home ownership.  There are many good resources and excellent advice at Gustan Cho associates or forums for professionals of the Real Estate and Mortgage industry.  We at the Larry Stepp Team would like to make ourselves available to inform and educate, we are available 7 days a week, holidays and weekends.

Larry Stepp    407-922-4755

The information contained on website is for informational purposes only and is not an advertisement for products offered by Loan Cabin or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates and do not reflect the policy of GCA, its officers, subsidiaries, parent, or affiliates.


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