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Why Were Credit Scores Created? How People Used to Get Loans

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Jan. 18 2022, Published 3:30 p.m. ET

Prior to three little numbers determining your fate on whether or not you can get a home or a new car, credit scores were all but obsolete. How did banks determine a person’s trustworthiness? In the past, when a banker decided if someone could borrow money, they just used their judgment.

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A consumer advocate for LexingtonLaw, Randy Padawer commented on lending decisions made by banks prior to credit score implementation. He said, "If you wanted to buy a house or a car, you would go to the bank and you would talk to a fairly vigilant, cynical banker.” When such big decisions came down to someone’s individual judgment, it wasn’t always accurate or consistent.

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How were FICO scores created?

Since lending was based on a banker's subjectivity, decisions were often discriminatory. Padawer commented on this fact and said, “There were questions of fairness and racial and gender bias on credit applications.” What also made the credit application process cumbersome was that it could take a lot longer to get a decision from lenders. The risk assessment was done manually and wasn’t based on any type of specific measuring criteria.

Around 1958, Bill Fair and Earl Isaac created the FICO (Fair, Isaac, and Company) score. The pair created the first credit scoring system to be used by a lender in the U.S. In 1989, the first bureau-based scoring debuted in conjunction with Equifax. By 1991, FICO scores could be accessed through all three of the major credit bureaus.

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By the early 1920s, Equifax was well established with offices throughout the U.S. and Canada. TransUnion started in 1969 as a railroad car leasing company and then started acquiring small credit agencies followed by Experian launching in 1996. FICO got even further into leading by expanding the use of credit. In 1995, Fannie Mae and Freddie Mac started using and recommending FICO scores for mortgage lending.

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Banker explains loan to loan applicant

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How do credit bureaus use credit scoring?

When the decision was made, FICO scores started being used for credit cards, mortgages, personal loans, and auto loans. In 2006, the VantageScore credit score started being used as an alternative to FICO reporting. The first versions of the VantageScore had a range from 501–990, but the most recent versions have a score of 300–850, which is the same as FICO’s range. The main difference between Vantage and FICO is how each score is categorized.

For FICO, the exceptional range is from 800–850, the very good range is 740–799, the range good is 739–670, the fair range is 669–580, and the poor range is 579–300, respectively. For the VantageScore, excellent is 850–750, good is 749–700, fair is 699–650, poor is 649–550, and very poor is 549–300, respectively. While credit reporting might be more effective now than relying on the mood of a random banker, it still has flaws.

According to a CNBC report, over one-third of Americans experience at least one error on their credit report. Meanwhile, 29 percent of people found personal information errors and 11 percent found account information errors. While these types of mistakes might not directly hinder a person’s credit score, they can create a challenge when trying to access a report prior to taking out a loan or buying a home or a car.

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