Will you allow your kids use your credit card? The answer is Ã¢â‚¬ËœNoÃ¢â‚¬â„¢ because your kid is not aware of how to use this. So whether an individual has adequate knowledge of managing credit is a matter of question from credit grantorsÃ¢â‚¬â„¢ perspective. Credit scoring is the mechanism to verify if an individual is capable to manage the credit in a proper manner. This is important for the creditors because they must be willing to know how much risk is there if they lend money to a particular person.
Mortgage lenders, auto loan companies, credit card issuers put much weight on credit scoring. This helps them decide the rate of interest, credit limit and many more important aspects of the transaction.
Credit scoring models are developed on the basis of consumersÃ¢â‚¬â„¢ data. One behavioral report is compiled based on statistical formula. Different creditors can use different scoring model or they can take help of some credit scoring companies. The most widely accepted scoring model is developed by Fair Isaac. Hence it is also known as known as FICO score. All the major credit bureaus use this model to calculate your score. Usually creditors compare the output of their own system with that of a common credit scoring company.
Credit bureaus do offer their own score. The score developed by TransUnion is known as Ã¢â‚¬ËœTransRiskÃ¢â‚¬â„¢ and that of Experian is known as Ã¢â‚¬ËœScoreXÃ¢â‚¬â„¢. There are creditors who like to concentrate on these bureau-specific scores because:
- These scores are comparatively cheaper than FICO.
- These scores often go very close to the risk factor in reality.
Most banks, mortgage lenders and other credit grantors build up their own modules to calculate credit score as well.
But it have been often noticed that the score computed on the basis of the formulae provided by FICO may vary from one bureau to another. Lenders tend to discard the upper and the lower score and use the middle one while calculating an individual's creditworthiness. Hence on 14th March, 2006 the three bureaus announced the rolling out of a new scoring model called the VantageScore. Its a new model and is intended to reduce the difference as much as possible.
Since the model developed by FICO, is based on statistical data it is expected to give accurate information than just a prediction. Credit scoring model is supposed to give unbiased result. The Equal Credit Opportunity Act, enforced by Federal Reserve BoardÃ¢â‚¬â„¢s Regulation B, strongly opposes discrimination on the basis of race, skin, sex, marital status, religion and nationality. So the statistical method to calculate credit score can never consider these factors to be part of credit scoring.