Having a good credit score can open major doors for you. You’ll be able to get a loan, lease a car, and purchase some other major items that you may have always dreamed of possessing.
But while you may have a fairly good understanding of how the credit system works, did you ever wonder how it came about?
The history of credit scores is an interesting one, and learning more about it can help you appreciate and value your own credit score even more.
Below, that’s exactly what we’re going to help you with, so read on.
Credit Scores and Americans Through Time
Credit scores are one of the most important factors in American life today. They determine almost everything, from creditworthiness to employment eligibility. It’s no wonder that there is so much interest in understanding the process that leads to these numbers.
The history of credit scores began when two men, engineer William R. Fair and mathematician Earl Judson Isaac, came up with credit-related algorithms in the 1950s.
Eventually, Fair and Isaac created Fair, Isaac, and Company, or FICO, with the initial aim of creating a fair system for banks to use when deciding which customers to give loans to. Along the way, a person’s credit history also came in handy for predicting their likelihood of future financial success.
Lenders first used credit scores to determine whether or not to give a person a loan. Over time, the use of these mighty numbers has expanded far beyond the banking industry.
Today, industries rely on credit scores for a variety of purposes, from insurance to employment, and even renting an apartment.
Growth in Consolidation
America’s credit reporting system began as a laborious, manual process until the 1960s when it was consolidated through computerization.
At the time, there were at least 2,000 credit bureaus all over the country, but the number would eventually drop to five over the next two decades and finally, three: TransUnion, Equifax, and Experian.
The popularity of credit scoring didn’t come so fast in the US, however, as lenders thought twice about releasing their evaluations of their clients’ creditworthiness.
The Birth of the FICO Score
Today, the most widely used type of credit score is known as the FICO score. Founded in 1956, FICO initially collaborated with clients to create credit scoring models that were unique for every type of business.
The common practice was for a company to hire FICO, which would then get hold of that company’s client files to create a customized system for assessing its customers’ risk level.
It was only in 1989 when FICO teamed up with the national credit bureaus to develop a single credit scoring model that would apply to all. That was the birth of the first generic credit score system, which made credit scoring unprecedentedly more accessible to lenders.
Eventually, FICO scores were established as a vital part of financial decision-making. It was also at this time that the federally backed home mortgage companies Fannie Mae and Freddie Mac started requiring people to provide their FICO scores when applying for a mortgage.
Credit Scores in Modern Times
Nowadays, lenders use a variety of credit scoring models, although FICO remains the most popular.
The company’s credit scoring models have also changed substantially over the years as a response to the ever-evolving behaviors of consumers. Today, FICO scores begin at 300 and max at 850, where a higher score is automatically interpreted as a lower risk for lenders.
Consumers’ social security records are also now tied to their credit scores permanently. Hence, even if a person changes their social security number, credit agencies will still be able to cross-check across various numbers accordingly.
Credit Scoring Criteria
Unlike older scoring systems, personal details like age, marital status, gender, and race are no longer factored into the generation of credit scores today.
Instead, the criteria now focus on more technical issues such as the individual’s payment history (35%), current credit accounts owed (30%), length of credit history (15%), new credit (10%), or how often the person opens a new account (10%), and credit mix (10%), or the variety of credit products the person uses, such as credit cards, mortgage loans, etc.
Judging by the said criteria, it’s easy to conclude that debt affects credit score at all times. Whether the impact is positive or negative depends on how the borrower manages their debts.
New Avenues Opened
Experian has begun considering monthly subscription and utility bill payments when running up credit reports. There are two groups of people who mainly benefit from this – first, those with poor credit who need to bump up their scores a bit, and second, those who are credit invisible or have no credit at all.
According to a report by the Consumer Financial Protection Bureau (CFPB), there are currently 26 million American consumers who are considered credit invisible.
This means one out of every 10 adult consumers in the country has no credit history whatsoever with any major consumer reporting agency.
The History of Credit Scores and Its Overall Impact
For over thirty years, credit scoring has been a vital part of the American credit system. Yet, few people know the surprising history of how this now commonplace tool got its start.
While the history of credit scores is relatively short, their impact on American life is enormous. In any case, it’s important to understand how they work and how they are used as this knowledge can help us make better choices about our financial future.
Think you could use more educational posts like this one? Help yourself and explore our blog!