How Valid is the Credit Scoring System?
With credit scoring systems, creditors are able to evaluate millions of applicants consistently and impartially on many different characteristics. But credit scoring systems must be based on large enough numbers of recent accounts to make them statistically valid.
Although you may think that such a system is arbitrary or impersonal, a properly developed credit scoring system can make decisions faster and more accurately than an individual can. Many creditors design their systems so that marginal cases ¾ not high enough to pass easily or low enough to fail definitively ¾ are referred to a credit manager who personally decides whether the company will extend credit to a consumer. This may allow for discussion and negotiation between the credit manager and a consumer.
With the help of sophisticated credit-scoring models, lenders are rummaging deeper into consumer backgrounds, enabling them to reclassify some formerly prime customers as subprime. The benefit to the lender: increased profits. All this adds up to a profound change in lending that has gone largely unreported. While officials have been cracking down on the worst abuses of subprime lending, other practices have exploded into mainstream lending allowing lenders to charge premium rates, exploit shaky credit histories, and suck borrowers into subprime for life.
National Home Equity Mortgage Association on subprime lenders report that the subprime borrower’s annual income is only about $3,000 less than prim borrowers, on average. They are school teachers, police officers, independent business people, lawyers, in some cases, and doctors and those with high income but equity challenged by big loans. Subprime debt comes in almost every form, including mortgages, refinance loans, credit cards, and new & used car loans. Total subprime lending increased tenfold in the last five years.
Credit bureaus have also become more meticulous. Today, they collect information that wasn’t typically reported before the 1990’s — bill-paying data from phone companies, utilities, and even hospitals. That rigor turns up more people who have missed a payment somewhere, sometime, on some bill.