You need a credit score to qualify for several different types of loans: home, auto, and personal loans, as well as credit cards. Insurance companies, in some states, use credit scores to calculate your premiums. You may even have to provide your credit scores to utility providers before you can start service.
Although credit scores affect several aspects of your life, they’re relatively new. In fact, it wasn’t until 1989 that the United States had a widely available credit score based on several standard factors. Learn more about the history of credit scoring to better understand how the industry has evolved.
Credit Reporting: A Prelude to Credit Scores
Before lenders used credit scores to assess creditworthiness, they relied on credit reports. These reports are older than credit scores by about 150 years. In 1841, the Mercantile Agency started collecting information about business owners. Ethnic background and marital status were just as important as a person’s credit history. Merchants in Boston and New York subscribed to the reporting service to help them determine if they should extend credit to certain business owners.
By the late 1800s, credit reporting agencies saw the value in collecting the same information about consumers. Buyers had more money to spend on furniture, clothing and other items, so retailers needed a way to assess their creditworthiness. CRAs continued to collect information about personal characteristics, including race and ethnicity, to help merchants make credit-related decisions.
Consolidation of Credit Bureaus
In the 1960s, the United States had thousands of credit bureaus. At the time, it was difficult for a single company to collect information about consumers from around the country, so credit bureaus were somewhat localized. In addition to collecting consumer data, these local credit bureaus collected gossip and used it to make reporting decisions, drawing the attention of the United States Congress.
As technology advanced, it became easier to share information across long distances, reducing the need for local credit bureaus. Thousands of companies consolidated, creating just three major credit bureaus: Equifax, Experian and TransUnion.
The History of Credit Scoring: Generalizable Scores Hit the Scene
For decades, lenders relied on subjective criteria to make decisions about loans, credit cards and other financial products. Many of them resisted the transition to standardized credit scores, as they preferred to use their own systems. It wasn’t until 1989 that the Fair Isaac Corporation, better known as FICO, created a credit scoring model that could be used for every consumer in the United States.
Today, FICO has several credit scoring models to help lenders make better decisions. FICO Score 8 and FICO Score 9 are the most widely used versions. FICO also has models specifically for auto lending, mortgage lending and credit cards. Each variation weighs each score factor a little differently, making it easier for lenders to manage risk. For example, FICO auto lending scores are calculated based on industry-specific risk factors, giving lenders the information they need to determine if a consumer is likely to repay a car loan as agreed.
Components of Major Credit Scoring Models
FICO’s models calculate your scores based on five key factors:
- Payment history: This portion accounts for 35% of your FICO score, making it the most important factor. Looking at your payment history helps lenders determine if you make your payments on time. Late payments reduce your score, so they can prevent you from being approved for a loan. Even if you’re approved, the lender can increase your interest rate to account for the increased risk of lending you money.
- Amounts owed: Using credit doesn’t automatically hurt your score, but having too much debt can make lenders worry that you’re overextended. This makes up 30% of your FICO scores, so it’s extremely important to avoid maxing out your credit cards and borrowing money you don’t really need.
- Length of credit history: If you have a long history of managing credit responsibly, it’s less of a risk to let you borrow money than it is to give a loan to someone with a short credit history. This factor accounts for the total length of time your credit accounts have been open, the age of each individual account and how long it’s been since you’ve used each account. Length of credit history makes up 15% of your FICO scores.
- New credit: If you open several new accounts in a short period of time, lenders may worry about your ability to repay a loan or credit card balance. This portion accounts for 10% of your FICO scores.
- Credit mix: Lenders like to see that you have experience managing more than one type of credit account. However, it’s not necessary to open accounts you don’t need just to achieve the perfect credit mix, as this factor only accounts for 10% of your FICO scores.
Strengthen Your Financial Future with Excellent Credit Scores
Credit scores have evolved over time, but the principles of establishing good credit remain the same. Make payments on time, avoid running up your balances and don’t apply for new credit unless you really need it. It’s also helpful to check your credit reports regularly to ensure there are no mistakes that could harm your chances of getting approved for a new account.
You might also be interested in: How Your Credit Score is Calculated
