Credit Scoring School

Credit scoring, to put it simply, is a multivariate analysis to assess the statistically significant relationship of a number of independent variables to a dependent variable, in this case, an index or "score" that reflects the probability that a consumer will repay his or her debts as agreed. Credit scoring was developed and continues to be refined by Fair, Isaac & Company (FICO), based in San Rafael, California. Credit scores have proved to be efficient in predicting whether or not a consumer will repay his or her debt as agreed under the contract. In addition, they have also been useful in evaluating applications for automobile insurance. According to Ruth Simon's excellent article in the Wall Street Journal, "some auto insurers believe that the credit scores are a better predictor of a client's propensity to file insurance claims than is the client's driving record." Quite appropriately, some marriage counselors have suggested that the prospective bride and groom exchange credit reports and scores.

There is a fairly powerful anti-scoring sentiment in this country. Credit scoring has frequently been attacked by consumer advocates as a "black box" that determines whether or not consumers would receive the credit so critical to functioning in our society. For example, some consumer advocates have demanded that FICO provide complete information about how the scores are calculated. Complying with this demand would, of course, destroy FICO's competitive advantage and discourage further refinements of the system. The "black-box" nature of the scoring process is likely behind the Washington state legislature's passage of a law that restricts the use of credit-based scores for home and auto insurance. Anti-credit scoring legislation has been introduced in at least 20 other states. Since passage of such legislation would make it more costly for credit grantors to assess the risk of credit applicants, consumers (voters) would ultimately have to pay more for their credit (and presumably for their insurance, as well).

In response to these attacks, FICO has taken a pro-active stance. Beginning this spring, consumers can access an on-line school that provides advice based on the formulas in the firm's credit-scoring system. For example, the consumer might find that reducing his outstanding credit card debt might raise his score by enough to obtain a better rate on a proposed auto loan. There is a small tuition fee.