It’s almost universally acknowledged that understanding the ins and outs of credit isn’t exactly an easy or pleasant task. It seems like every time we sit down to check our credit scores and reports we end up with more questions than answers – how is my score calculated? Why hasn’t my score gone up? Am I doing the right things to boost my credit score? It’s exhausting! There has to be a better system, right?
Interestingly, the credit scoring system we have today, though prone to criticism, is a huge improvement over the mish-mosh of methods used to determine creditworthiness in the past. Take a look at the information below for a brief history of FICO, the major credit scoring model we use today – you’ll be surprised at how far we’ve come!
Prior to the birth of the credit score, banks used a variety of very arbitrary methods to decide whether you were worthy or not of obtaining a loan. For example, if a customer came into his local bank looking for a mortgage, the banker might look at his overall financial situation – like how much he had in savings, how much he had borrowed in the past – but personal factors would also be considered. Did he have a reputation for drinking? Did he cheat on his wife? These factors could prevent the customer from obtaining a loan.
Also, it’s not a coincidence that the example above featured a male borrower – banks didn’t typically lend to single women or minorities prior to the birth of the FICO score.
FICO Is Born
In the 1950s, a team comprised of a mathematician (Earl Isaac) and an engineer (Bill Fair) began toying with a formula that would use a variety of factors to mathematically compute a person’s creditworthiness. Once perfected, the team founded a company known as Fair, Isaac and Company and began peddling their formula to the many credit reporting agencies that were around at the time. Eventually, these many agencies consolidated into just three – Equifax, TransUnion, and Experian – and by the 1990s all three were using Fair and Isaac’s formula for producing comprehensive credit scores for banks to use.
Fair, Isaac and Company went public in 1987, and in 2003 became the Fair Isaac Corporation (FICO). Because the use of a credit score is now common practice among banks, the success of the FICO has caused a number of competitors to enter the market. However, the FICO scoring system still remains the most widely-used method for assessing a borrower’s creditworthiness.
Although the current credit scoring system has its critics, it’s certainly better than the unfair and discriminatory practices used in the past. Knowing all this won’t improve your own credit score, but hopefully it will make you feel thankful that you have a score at all!