A Brief History of the Credit Score
By: Geff Woodward
Credit can be confusing. For the average American, credit knowledge is likely left to the wind, often remaining a mystery. Understanding the history of credit and credit scores can actually help us understand how we can better utilize the system that exists today.
When credit reporting first began, there were more than 2,000 credit bureaus across the United States. Over the course of the 20th century, that number shrunk down to just three. This remains the case for the credit bureaus that exist today.
During the 1950s, lending institutions started to develop analytic solutions, such as credit scoring, in order to evaluate a consumer’s ability to both qualify for credit and/or loans and the likelihood that said consumer would be able to repay the credit and/or loans for which they qualified. These initial credit scores were very rudimentary as they were built over the scarce data that was available at that time. Lenders were also hesitant to let consumers in on what they were assessing in order to evaluate someone’s creditworthiness. This was most likely due to personal bias and discrimination that was heavily ingrained in society at the time.
This personal bias and discrimination ultimately led the government to establish the 1974 Equal Credit Opportunity Act, which banned a lender from denying credit to a consumer based on gender, race, nationality, religion, or age. Credit scoring adoption accelerated in order to shield against discrimination lawsuits until the FICO (Fair Isaac Corporation) score was launched in the late 1980s. FICO became the first “generalizable” credit score. They were able to do this by working with the national credit bureaus to create a credit scoring model that could be used to evaluate all consumers in the same manner.
This then begs the question of how exactly is the FICO score calculated? The FICO score was developed using the only data and metrics which were easily available in those days. This criteria remains mostly untouched since then. The current components of a credit score are as follows:
(35%) Payment history
(30%) Amount owed
(15%) Length of credit history
(10%) Credit mix
(10%) New credit accounts
As anyone can see, these metrics do not measure someone’s creditworthiness, nor their ability to service any credit and/or loans for which that consumer qualifies. In fact, these metrics often actually promote consumer debt up to the edge of the financial cliff. Credit scores are enhanced by having multiple credit cards, the continued use of those credit cards, and having installment loans. Yet, those consumers who are financially secure do not use multiple credit cards. Conversely, those consumers who self-finance expenses are provided with a low credit score that is inaccurately assessed. On top of that, despite efforts to give everyone an equal opportunity, bias still finds its way into credit scoring.
In this series, we will continue to discuss and break down our knowledge of credit. An often opaque topic, our goal is to make it more transparent for the average American. We are also looking to explore a potential solution - an alternative to the credit score. It’s time that history adds another chapter to the credit story!