Credit Bureaus Used to Have a Faulty, Unsystematic Way of Reporting
Before the development of the FICO Scoring Model by Bill Fair and Earl Isaac in 1956, there was no rating system or criteria in place to determine consumer credit worthiness. Department stores and finance companies established small, local credit bureaus to determine a consumer’s true risk factor. These unregulated credit bureaus allowed their employees to make final decisions about extending credit to consumers.
The local credit bureaus operated in silence and used concealed methods to gather information about consumers. They gathered information such as employment history, marital status, age, religion, and testimonials, just to name a few. Consumers, however, had no right to view their credit file. Unfortunately, there was no protection in place to protect consumers from credit errors. This faulty system left much room for discrimination in the credit reporting industry.
The Welcome Wagon Isn’t So Welcoming
Have you ever heard of or had experiences with a Welcome Wagon? Before the internet era, the Welcome Wagon was partnered with the credit bureaus! Part of their practice was to hand-deliver baked goods to their new neighbors in an informal “Welcome to the Neighborhood” visit. During their visit, they would gather as much information about the “new” neighbor as possible. By inspecting the home, the Welcome Wagon could determine the person’s financial situation by noting things like the quality of furniture and fine China. They would even pay attention to of the number of children living in the home. This was how local businesses and lenders gathered information about the new people in town.
The Credit Bureaus First Run-In with Regulation
In 1906, the Associated Credit Bureaus were established. The Associated Credit Bureaus, or ACB, was put in place to facilitate the goals of local credit bureaus and develop a cooperative interaction between them. This was the credit reporting industry’s first step towards reporting consistency. However, because this was developed prior to the web, much of the consumer information was collected and transmitted in print. The unreliability of this credit review system caused credit card companies and lenders to lose revenue because they were extending credit to un-creditworthy consumers.
Although the ACB laid the foundation for the three major credit bureaus that we all know today, there were still too many loopholes in the system. The Federal Government was receiving many complaints about discrimination in the housing loan industry. Credit bureaus were beginning to lose credibility and needed to do something major in order to stay in business. Due to immense pressure from Congress, lenders agreed to rid of their old system of gathering information. This decision was made not because lenders realized that they were doing a disservice to the community, but because this was the only way that they could stay in business.
To help govern the consistency and reliability of credit bureaus, congress developed the Fair Credit Reporting Act (FCRA) of 1971. This law enforced all credit reporting agencies to rid of the old system of gathering and obtaining information about consumers. Over time, information on consumer credit reports would become more reliable. This new development revolutionized the credit reporting industry,
The old system was completely done away with and replaced with the FICO Scoring System. Bill Fair and Earl Isaac determined that a systematic method of using data will help lenders and credit companies make better business decisions. The integration of the FICO system used mathematical algorithms to create the credit report and calculate the credit score. The FICO Scoring Model is broken down into 5 categories: Payment History, Revolving Debt Ratio, Average Age of File, Mix of Credit, and Inquiries. Max Score Credit’s A.C.T. system is designed to impact all 5 categories of the FICO scoring model.
With the development of FICO, underwriting for lenders become a much faster and more effective process. Lenders could make credit decisions based on the credit score, rather than having to read and/or understand the entire credit report. Underwriters no longer needed in-depth credit knowledge to analyze true risk factor. The downside to this is that consumers were being judged as three-digit numbers, not individuals.
Presently, there have been many developments in the FICO Scoring System. Fico has formulated many different versions of their scoring model so that different companies can use industry-specific data to asses a consumer’s true risk factor.
Credit reporting has come a long way. It was once secretive, discriminatory, and unregulated. Although there are still some inconsistencies in credit reporting, consumer credit data is now fully protected under the law. Inaccurate and unverifiable data must be removed from the credit report, according to the FCRA.
FICO has recently developed a new scoring system called Vantage Score 3.0. An advantage to Vantage Score is that it does not recognize paid collections, which negatively affects the credit score under the stipulations of the FICO scoring model. Also people who are not able to have their FICO scores generated, for various reasons, will not have any difficulty generating scores using Vantage Score. It may take years for companies to incorporate the Vantage Score System into their credit decision-making. However, it will be interesting to see how this system transforms the credit reporting industry.
– Jakira Williams