What’s the Benefit of Using FICO Scores?
FICO scores are used by the majority of credit grantors and are used more than any other score brand. FICO credit scores have been used since the late 1980’s and the FICO score has become an industry standard. Lenders benefit from using the scores because they are faster than manual underwriting and yield a more consistent evaluation of the consumer risk, or lack thereof.
More Efficient Than Manual Underwriting
Prior to credit scores, credit grantors manually reviewed applications and credit reports to evaluate risk. This took time and made the credit granting process long and drawn out. Lenders used credit applications, bank account information, credit file information such as past and present payment history, plus their experience to assess risk. They depended upon their previous experience to make a decision.
Now the underwriting process includes FICO scores. The use the same information, plus FICO scores. The scores place consumers into risk ranges, which help the lender determine pricing and credit qualification. These ranges are based upon the lenders’ previous experience with delinquencies and profit, based upon the scores. Those with more risky scores pay higher interest rates.
For example, two consumers purchase the same car for $25,000 with financing for 36 months. One has a FICO score of 750 and pays $747 monthly at an interest rate of 4.789%. To quality for these terms you must have a score in the range of 720-850. The other has a score of 650 and pays $828 monthly at an interest rate of 11.761%, or $81 a month more. To qualify for these terms you must have a score range of 620 to 659. Same car, different price to finance it.
A More Consistent Evaluation
Every applicant or customer is evaluated on the same criteria in their credit file. The manner in which the score evaluates the credit report does not change. The same value is given for the same information because the score is objective. And finally, credit scores don’t care who gets approved and who gets denied. That’s the lenders job to determine.
FICO scores are available at all three consumer credit reporting agencies: Equifax, Experian and TransUnion. They are designed so the scores have the same meaning at all three. For example, a score of 720 means the same at each of the three credit bureaus. Since most lenders, except mortgage lenders, don’t purchase three credit files to make a decision; they are looking for consistency in the score they are using to make a credit decision.
So, before you rip on credit scoring systems think back to the day when it took 90 days to get a loan decision.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. Follow him on Twitter here.