A Brief History of Credit Scoring

Years ago, when  I was employed in the mortgage business, a new way of mortgage underwriting was born: credit scoring. Prior to this, mortgage underwriting was mostly a manual assessment by an underwriter using a credit history, employment data, and a host of other metrics. For example, being employed in the civil service sector was considered a plus, as layoffs are rare. That could buy someone forgiveness for a few late payments in the past. These were classified as “compensating factors.”

One day, at a meeting, we were handed a 50 page booklet from a firm called Fair, Isaac & Co. Never heard of them. But inside the book, there was a full explanation of how a credit report could be automatically processed to yield a score that determined risk. I didn’t understand the methodology shown in the book, as the charts and details were hard to grasp.

Months later, at a conference of mortgage industry professionals, the then head of Fair, Isaac said he aimed to make a person’s FICO score as important as one’s social security number. It turned out to be no idle boast as the years went by.

We didn’t know it at the time, but this was one of the first, if rather primitive, stabs at artificial intelligence.  Instead of having a human underwriter assess the amount of credit outstanding, the number of open accounts, the number and history of late payments, etc., the FICO system pulled up an assessment in seconds, by balancing all of these metrics, and coming up with a single score that placed the borrower in a risk bracket. From there, rates and terms were determined.

This was the beginning of a revolution in credit assessment called “predictive metrics.” Calamities like the 2008 financial crisis still proved no one could predict the future, however.

In the early days, it was easy to game the system. FICO didn’t “like” high usage on credit card accounts, and I learned if the borrower partially transferred balances from one high use account to other unused, or little used accounts, I could juice a credit score by 50 points, even with the same total amount of credit outstanding. It took a few years for Fair, Isaac to wise up to this, but not before I turned a few mortgage clients from “B” paper to “A” paper applicants in three weeks’ time.

Pretty soon, I learned what FICO wanted to "see" in a report, and if I had the luxury of time, I could advise a client to sculpt their credit profile in a manner that would raise their score. But here too, Fair, Isaac refined their methods and it became harder to do this.

Since those early days, FICO has gotten some competition, notably from the credit repositories themselves. The scoring methods have also morphed into several categories. There are scoring systems dedicated to auto loans, for example, which are not based on what is called an “RMCR,” or Residential Mortgage Credit Report, which was the standard used back in the day.

You might find these a bit superfluous, but no one is in business to turn down loans, and if the score can make the shoe fit from a specifically targeted credit profile and produce a sale, so be it.

Given my early experience with scoring, I found it funny how people would actually pay someone to improve their credit score as a service. There’s no need for this besides the application of common sense.

A few basics to keep your score in good shape:

Keep a maximum of four revolving credit card accounts. You have to understand something very conflicted about the credit business: they don’t want to see you have too much of a line of usable credit available, but a strong payment history will ensure the credit card companies will keep raising your card limit anyway. So while your score may suffer from using 80% of a card’s credit limit, your issuer certainly isn’t complaining about it, especially at interest rates over 20%. Don’t get sucked in. Because the minute you really need access to funds, you’ll be caught flat footed.

Which leads us to rule Two, which is keeping credit balances at least below the 50% level. Under 30% will pump your score even higher, but many people can’t resist living on the float. But whatever you do, don’t wade into the deep part. Nothing erodes savings and purchasing power more than credit card interest rates. Not even inflation.

One trick I use: I keep an active credit card that I never use, and always shows a zero balance. It remains in a drawer and collects dust. This keeps your overall credit use percentage down, even if your usage goes up on the cards you regularly use.

It seems to me that scoring is more volatile than it used to be. As an example, I recently moved, and given the costs, I used my credit cards extensively during this period. My score quickly dropped 50 points, but I don’t believe my status as a credit risk increased during this time. We use plastic for almost everything these days, and I avoid using debit cards for security reasons.

Nevertheless, be aware that large purchases, even if not done out of self-indulgence, will move your score quickly. Paying these off just as quickly should rectify this in short order. I mention this because I think the scoring metrics should be more capable of taking a longer-term view of credit usage, and not drop kick a score simply for paying a moving company. 

Not having a mortgage history is a demerit in the scoring industry. So if you’ve never had one, you may have to be more fastidious in your credit usage if you’re looking to make a major purchase and you need “Top Tier” scoring for a lower rate, such as for a car lease, where rates charged are very sensitive to your score . However, having any kind of fixed rate loan paid off cleanly in your history with no issues, is a plus.

You’ll note that there are several different scores available. People will try to sell you a package of scores from all three major repositories, but you can save your money. Qualitatively, unless one of them has an error on it, all three scores will cluster in the same risk bracket.

Yes, there are sometime errors, but remember that every retail transaction made by a card holder, even for something like a pair of socks, is duly recorded on the reporting system, so it’s not reasonable to expect perfection. But it pays to check for accuracy from time to time.

If you’ve gotten into trouble before on things like medical expenses or collection accounts you’ve since satisfied, some states mandate their removal after a short period of time. Since there’s no national standard, the repositories won’t do it for you unless you write to them and ask. Removing these past credit blemishes will greatly enhance your score.  Simply contact the repositories on their websites. Some of these can be tackled with an on-line submission, which is a great convenience.

Credit scoring today can provide an instant approval of tens of thousands of dollars’ worth of access to credit. It’s revolutionized commerce in dozens of ways, and in its own way, is an unsung component of a turbocharged consumer economy.

10/17/24