Credit
The FICO score
FICO is an acronym for Fair Isaac
Corporation (traded publicly under the symbol FIC) and usually refers to
the best known credit score system in the United States which is
calculated using different mathematical
formulae developed by this company. This score is one of the most
important factors in obtaining credit in the United States of America and
demarcates you into categories fit to receive good or bad credit
treatment. In institutions which use scores as the primary factor in their
lending decisions, scores below certain numbers which is usually set by
each lender's risk management department, may result in denial of credit
or the credit being offered at a higher interest rate.
The three major credit
reporting agencies in the United States of America, namely Equifax,
Experian and Trans Union, calculate their own FICO scores, which go by
different trademark names as well as many different versions of the score,
and these often differ because of what they are meant to predict and when
they were written originally. For instance, Beacon, Beacon 96 and the
Pinnacle are available only from Equifax; Empirica Auto 95 Precision Score
and Precision 03 available only at Trans Union, and Fair Isaac Risk Score
available only at Experian. These versions which were all developed for
the respective agencies by Fair Isaac, differ from one another and are
updated periodically to include changes and reflect the consumer's current
repayment behavior. The NextGen scores are the most recent addition to the
list of scores, but creditors vary in terms of their choice version that
they prefer to use.
These scores often use
a multiple scorecard design. Each version uses 10 or more individual
scorecards, and each of these individual scorecards are generally compared
with similar others. For instance, a borrower with two one month old late
payments will be scored against a population with a few minor
delinquencies. The individual in question is then graded according to the
variables that seem to indicate a repayment risk in that group. This
feature can cause a borrower with delinquencies to score in the same range
as a borrower without any delinquencies.
It is worth mentioning
that each of these credit reporting agencies have also developed their own
separate proprietary versions of a credit score that is intended to
compete with Fair Isaac's score. Although not as popularly used, these
scores like Trans Union's TransRisk score or Experian's ScoreX score are
less expensive than the FICO score and, in certain situations, may predict
the risk level of a prospective borrower more accurately. The cost savings
of a non-FICO score are found to be tempting to some banks and credit card
companies, who desperately need an accurate risk assessment on millions of
accounts every year. Only time will tell whether these alternative scores
will ever manage to displace Fair Isaac from its dominant position in the
U.S. market when it comes to credit scores.
Almost all large banks
also have a practice of building and using their own proprietary
statistical models for credit scoring purposes, often in conjunction with
the FICO score or other outside scores. The statistical models that
generate credit scores are most often subject to regulations as laid down
by the federal government. The Federal Reserve Board's Regulation B, which
implements the Equal Credit Opportunity Act, explicitly prohibits a credit
scoring model from considering any prohibited basis such as race,
religion, national origin, color, sex, or marital status for the
calculation of the same. Regulation B also dictates that credit scoring
models need to be empirically derived and statistically sound. Moreover,
if any adverse action needs to be taken as a result of the credit score,
for example if an individual's application for credit is denied, then
specific reasons for the denial must mandatorily be provided to the
individual. A simple statement that the individual failed to score high
enough is insufficient; the reasons must necessarily be specific and
detailed.
There are several
generally accepted algorithms that exist for extracting the primary
contributing factors to a low credit score. One or more of these
algorithms are normally used to supply a list of reasons in the event that
a loan applicant has been denied credit, in order to satisfy the
Regulation B requirement that specific reasons are disclosed. Some
consumers feel these adverse action reasons are somewhat insincere, as the
only determining factor for credit denials is a numeric score and the
reasons are summed up only for the consumer.
As we have already
seen, each credit bureau also has one or more of its own generic credit
scores, available both to consumers on their websites as well as lenders.
For ease of use, these scores are usually mathematically scaled so that
they fall in the same general range as the FICO score. These scores are
used by some businesses to assess credit-worthiness in the absence of
which they would not be offered; however the FICO score continues to be
the dominant score in use today. Fair Isaac currently offers scoring
models for the U.S.A., Canada, and South Africa. It also offers a "Global
FICO" for many other countries across the world.
