Friday, April 12, 2013

A History of FICO Scores and Why We use them - Part One

We have spent a lot of print on what goes into creating your FICO score. We know who FICO is, Fair Isaac Company, and they invented the score. We have learned the five factors that go into it; Payments, Balances, History, Inquiries, and Types of Credit and how each of these factors are weighted. We have learned how FICO scores are affected by debt and collections. What we have not covered is why FICO exists at all. Why do we need FICO Scores?

Back in the day, we used your entire report, read it page by page, to learn how you manage your credit. We would check your collections, payment histories, and other data in making a lending decision. It took time to make loan decision. It was not like today where lending decisions can be made instantaneously online or within 24 hours of receipt of the application. Often, two or three people would have to review a loan file before it could be approved. That all changed with the advent of the FICO Score in the 1950’s.

Okay, so FICO saves us time in getting loan approvals. How did it come about?

In the 1860’s, a few regional credit bureaus started to crop up. They maintained lists of people or businesses that used credit and kept a record of their credit volume and payment histories. This allowed merchants to give credit to their customers without having to have a personal relationship with them as had been customary in the past.

In 1898, the first national credit bureau opened its doors. The Retail Credit Company, later to be known as Equifax, was born in Atlanta. For $25, merchants could get a list or “Merchant’s Guide” that listed those who were known to have good credit habits and would be a good credit risk. For many years, the Retail Credit Company (Equifax) would be the only game in town, and in the USA for that matter, where financial institutions and other lenders could gather information to judge risk when lending.

In 1900, the first versions of a credit card were issued. “Proprietary Cards” were issued by oil companies and department stores to good customers. This allowed these customers to purchase goods and pay them back at a later date. The cards were only accepted at the issuing store. While modern credit cards are issued for consumer convenience, “Proprietary Cards” were issued as a means of stimulating customer loyalty.

What about the other two credit bureaus? Where did they originate? In 1866, UTLX started doing business. They were a manufacturer of tank cars to be pulled by trains. Later, they started their own credit bureau and were known as TransUnion. In  1901, the Cleveland Cap and Screw Company was founded and that was later to became known as TRW and, eventually, the Experian Credit Bureau we know today. These companies, TransUnion and Experian, started tracking consumer credit usage in the 1960’s.

Between World War II and the advent of the other two credit bureaus in the late 1960’s, there was an explosion in credit! Prior to WWII most lending was local; merchants provided credit to local families or businesses. Many loans were made on the basis of bank references and personal recommendations. During this time, the ability to check someone’s credit on a nationwide basis had not been established.

As G.I.’s returned home after the war, the job market expanded and the demand for consumer products and home purchases grew dramatically. Loan volumes grew and financial institutions hired large numbers of loan processors and loan underwriters. As volumes grew, processing times got longer and customer patience was shorter.  

Finally, someone asked the question, how can we judge someone’s credit without having to read the entire credit report?

Check out Part II of our History of FICO Scores coming in next week!

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This month's Financial Education Workshops are taking place at our Monta Loma Financial Center in Mountain View: 580 North Rengstorff Ave, Mountain View CA. Please RSVP for either of these workshops at this link.

Auto Financing 101       April 17th at 6pm    Monta Loma Financial Center
Learn what insiders know about the auto buying process. What tricks do dealers use to get you to buy? Is my interest rate negotiable? How do I get the best deal on a purchase and financing? Meet our Personal Auto Shopping Service Manager, Bill Fultz who has 25 years of experience at car dealerships and now shares his knowledge with our members. 

Credit Myths and Repair    April 24th at 6pm   Monta Loma Financial Center

Learn how collections, credit inquiries, and late payments effect your credit score. What is a FICO score? You will learn how to access your credit report and your credit score for free.

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