If you require credit and the lender does not know you, then something is necessary to give guidance as to if you are a good risk or not. Your income does not really say anything about you to a lender, as a high salary is no indicator of a responsible payer. Even when security is required with a major loan such as a mortgage, the lender does not want to deal with the complications and expense of pursuing late or missed payments. Thus the credit score was devised to give a likely indication of fiscal responsibility by the borrower, and to reduce the time which lenders spent on underwriting.
Credit scores are compiled from the data held on credit records, which are in turn compiled by the credit bureaus. The most commonly known and used credit score is the FICO score, issued by the Fair Isaacs Corporation, and is seen as an industry standard as each financial institution will understand the number presented. The FICO score can never be a guarantee of how a borrower may act in the future but is assessed and reached by records which reflect the customer’s prior financial history.
The score is compiled by technical analysis and algorithms which are now, to a certain extent, known to interested borrowers who want to ensure their own score remains high. Those with poor credit scores are deemed not credit worthy due to their past handling of finances, as payments on loans, credit cards, mortgages, utilities and other financial obligations are recorded when late or missed. The reports are simply accurate records of how you have managed credit in the past, although reporting errors can occur.
The FICO score has turned into a rich business for Fair Isaacs who are now being challenged by competition. The Vantage Score is being tested by several financial institutions and is already used by some, and this is a score derived from an alliance of the three main credit bureaus, Experian, Equifax and TransUnion. It stands as a potential rival to FICO which has almost a monopoly on scores at the moment, and is used by most lenders apart from those who use their own in house analytics to determine creditworthiness.
FICO works as a business by selling its score onto lenders. The three main bureaus want to be able to sell their own score system directly to lenders and thus bypass the current necessity of FICO. However the consumer is likely to be the one confounded with confusion as Vantage use a different score number range to FICO, thus a high Vantage score may be misleading to a consumer who believes it is a FICO score, as the FICO score will be lower.
The initial concept of a credit score to determine creditworthiness was an industry necessity: however the FICO score is now used for so many other things beyond its original purpose that consumers are often held hostage to their score. They can lose out on employment opportunities or pay higher interest rates, if their scores are not of the highest.
Currently there is an untapped market as 25% of Americans do not deal with credit, whom the financial institutes want to win over as customers. If the industry is successful in bringing credit to them they will be an unknown quantity, as those who have never dealt with credit are in the unique position of not having a credit score.