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A Brief History of Credit Scores
Your credit score is, for better or worse, one of the more important numbers in your life.
You likely have at least one credit file with the major credit bureaus (Experian, Equifax, TransUnion) if you’ve ever borrowed money. Everything from credit cards, student loans, and auto loans show up on credit files.
It’s estimated that more than 200 million Americans have credit records at one of the big three credit reporting agencies, according to the Consumer Financial Protection Bureau.
The credit score is a three-digit number calculated by a credit scoring system intended to help lenders analyze a borrower’s risk. Many lenders use this number to determine your credit risk. It helps them determine how likely you are to repay a loan and it helps set the loan’s interest rate.
So, how did this single number come about?
The start of modern credit bureaus
Credit bureaus started to emerge in the 1800s. Businesses used them to determine who they could trust to extend credit to. As the U.S. urbanized, lending became difficult. When a borrower moved to a new town and needed credit from a bank, there wasn’t a standard way to verify if someone would be able to repay their debts. Mass consumerism made businesses less aware of their customers. Businesses had to find a way to determine who they would trust to pay their debts.
“The modern credit economy wouldn’t have been possible without these credit bureaus,”says Josh Lauer, an associate professor at the University of New Hampshire who studies consumer and financial culture. “Credit scores and credit reports help people who don’t know each other make calculations to determine who they can trust.”
Businesses started the nation’s first consumer credit bureau. Credit bureau agents collected credit and personal information from landlords and employers about individuals (e.g., debts, moral character, marital status, etc.). They would also collect newspaper clippings and public records from courthouses.
The information collected in these files was primarily qualitative. So, in the 1930s, department stores decided to move in a more quantitative direction - based on this information, they started to assign points to individuals to gauge their creditworthiness. But this credit scoring system was anything but research-based. Individuals would earn points based on characteristics such as their race, income, neighborhood, and employment status, all in an attempt to determine someone’s morals.
The start of the credit score
A credit scoring system that used personal traits to determine a borrower’s likelihood of debt repayment would be overtaken by a more statistical approach.
In 1956, engineer Bill Fair teamed up with mathematician Earl Isaac to create Fair, Isaac and Company, with the goal of creating a standardized, objective credit scoring system. In theory, a standardized rubric would eliminate the prejudice that was inherent in the credit evaluation and lending practices that had been used for many years. Today, Fair, Issac and Company goes by a different name: FICO.
In the 1950s, the credit industry was resistant to adapt to the new, standardized method, as character assessments had been foundational to consumer lending up until that point. Only one company, American Investments, took up Fair Isaac's system when it began selling its statistical scorecard in 1958.
National department store chains were early adopters of the system when it debuted in the late 1950s, but credit card issuers, auto lenders, and banks soon followed. They needed a dependable, efficient, and quick way to gauge a borrower’s creditworthiness, and the Fair Isaac system provided this for them.
By the end of the 1970s, most lenders were using credit scoring.
The current FICO score system premiered in 1989 and has become the industry standard. It is a number between 300 and 850 determined by the following factors (by descending level of importance): payment history, amounts owed, length of credit history, credit mix, and recent credit inquiries (or new credit). Everything from bankruptcies to late payments factor into your credit score. The credit scoring system is occasionally tweaked to accommodate the evolving role of consumer credit and credit-related data.
FICO Score 9 debuted in 2014 and is widely used by the three major credit bureaus. In this credit scoring model, rent payments are included, medical debt isn’t weighed as heavily, and collection accounts that have been paid aren’t included in the calculation of your score.
Finally, the mortgage market's adoption of credit scoring added to the ubiquity of credit scoring. In the mid-1990s, Freddie Mac and Fannie Mae started pulling FICO scores for their automated mortgage underwriting system.
A brief history of the credit bureaus
The three major credit bureaus, Experian, TransUnion, and Equifax, track your personal financial information to determine your credit score. They all use credit scoring models created specifically for them by the Fair Isaac Company. These three credit bureaus also joined together to create the VantageScore Solutions system, a competitor to FICO. VantageScore is used by financial institutions, lenders, and landlords to assess a person’s creditworthiness.
Equifax is the oldest of the three credit bureaus, dating all the way back to 1898. It was started by a Tennessee-based grocery store owner who assembled a list of delinquent customers. It was called the Retail Credit Company in 1899 before changing its name to Equifax in 1975.
TransUnion was founded in 1968 the parent company of a railroad leasing organization. Just a year later, they acquired the Credit Bureau of Cook County. As early adopters of technology, they created an online information system and retrieval data processing system to help assist with tracking and maintaining consumer information.
Experian, previously known as TRW Information Systems and Services, Inc., has its roots in the 1800s, when various organizations were beginning to share information about customers who had failed to pay their debts. In 1968, the company acquired a company called Credit Data, making TRW one of the five largest credit agencies in the U.S. In 1996, after a reorganization, Experian as we know it was born.
The impact of credit scoring on consumer lending
Given that the purpose of the FICO credit score was the creation of a more fair system, was that goal achieved?
There’s no doubt that the standardized, objective approach to credit scores has given many people access to lending, but the credit score is far from perfect.
Some things you can’t explain to an algorithm, such as a job loss that caused you to have difficulty paying your credit card bill.
“Because credit decisions are automated, instead of talking to an individual, you’re dealing with data in a credit bureau that you don’t necessarily have access to” Lauer says. “ A system that seems democratic and objective can be individually unfair and sometimes cruel.”
The credit invisibles and credit unscorables
Even with the rise of credit bureaus and credit scores, many people still don’t have access to borrowing or don’t have enough information for a credit file.
It’s estimated that 26 million Americans are “credit invisible,” meaning that they don't have a credit history with one of the major credit bureaus. Another 19 million Americans are “credit unscorable,” meaning they have few or no accounts within their credit file or don’t have any recent credit history.
Even if an individual is an excellent money manager, lacking a credit score can impact the cost of borrowing or even shut them out of borrowing altogether.
A FICO score is probably a more impartial way to handle credit approval than just having a credit manager make subjective judgments about potential applicants. But algorithms can make mistakes and show discriminatory biases. For example, some algorithms reinforce racial disparities. While the scores themselves may not be discriminatory, credit inequalities have been shown to further the racial wealth gap.
“On average, black Americans have lower credit scores than white Americans, which is evidence of what is embedded in society is reflected in the data” Lauer says.
According to a 2020 report by The Urban Institute, FICO scores for Black borrowers were 125 points less than those for white borrowers in 2018. During that year, Black consumers were also more likely than white consumers to not have a credit record.
The Bottom Line
Because of the FICO credit score, credit applications are processed cheaply and quickly. The credit scoring model has also led to changes in the way credit is priced. The existence of the credit score has created a wider range of interest rates, where risky borrowers end up paying more interest and safe borrowers pay less.
Credit scores have changed significantly since they were introduced. There is still much to be done to improve the system and give everyone access to credit.
Knowing the information that is on your report can help you understand what lenders see when they determine your creditworthiness. If you’re curious about what’s on your credit report, you can obtain a free copy of reports from the three major credit bureaus at AnnualCreditReport.com. Because of the Fair Credit Reporting Act, consumers are entitled to see their report for free yearly.