Credit Scoring:

What does it mean for consumers?

Ever wonder how a creditor decides whether to grant credit? For years, creditors have been using credit-scoring systems to determine if a customer would be a good risk to credit cards and auto loans.

What is Credit Scoring?

Credit scoring is a system used by creditors to help determine whether to grant credit to customers. Information about their credit experiences, such as bill paying history, number and type of accounts, late payments, collection accounts, outstanding debt and the age of their accounts are all used in credit scoring systems. A credit score awards points for different factors detailed in your credit report which helps predict who is most likely to repay a debt?

Why is a credit score used?

Because credit scoring is based on real data and statistics, it is usually more reliable than subjective or judgmental methods. It also treats all applications objectively.

How is a credit scoring system developed?

To develop a credit scoring system a creditor selects a random sample of its customers and analyzes it statistically to identify characteristics that have been show to relate to creditworthiness. Then each of these factors is assigned a weight based on how strong a predictor it is of who would be a good credit risk.

What factors are considered by a credit scoring system?

Factors that have a negative effect on credit scores include past due balances, spending close or at credit limits, too many new accounts, insufficient length of credit history, too many revolving accounts, collections or charge offs, and bankruptcy.

How reliable is the credit scoring system?

Credit scoring systems enable creditors to evaluate millions of applicants consistently and impartially on many different characteristics. Although such a system may seem arbitrary or impersonal, if properly designed, it can make decisions faster, more accurately and more impartially than can individuals. Many creditors design their systems so that marginal applicants whose scores are not high enough to pass easily are referred to a credit manager who decides whether the company or lender would extend credit.

When credit is denied or terms are not favorable?

If credit is denied under federal law a creditor must give the consumer notice that tells either the specific reason the application was rejected or that the consumer has the right to learn the reasons if they ask within 60 days. If a credit report was used in the credit scoring process the consumer also has the right to see that report if requested within 60 days from the date of the denial.

For more information regarding credit scoring visit the Federal Trade Commission at FTC.gov.