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Credit
Scoring
Credit scoring is a system creditors
use to help determine whether to give you credit.
Information about you and your credit experiences, such as your bill-paying
history, the number and type of accounts you have, late payments, collection
actions, outstanding debt, and the age of your accounts, is collected
from your credit application and your credit report.
Using a statistical program, creditors compare this information to the
credit performance of consumers with similar profiles. A credit scoring
system awards points for each factor that helps predict who is most
likely to repay a debt. A total number of points-a credit score-helps
predict how creditworthy you are, that is, how likely it is that you
will repay a loan and make the payments when due.
Why is credit scoring used?
Credit scoring is based on real data and statistics, so it usually is
more reliable than subjective or judgmental methods. It treats all applicants
objectively. Judgmental methods typically rely on criteria that are
not systematically tested and can vary when applied by different individuals.
How is the credit scoring model developed?
To develop a model, a creditor selects a random sample of its customers
or a sample of similar customers, if their sample is not large enough,
and analyzes it statistically to identify characteristics that relate
to creditworthiness. Then, each of these factors is assigned a weight
based on how strong a predictor it is of who would be a good credit
risk. Each creditor may use its own credit scoring model, different
scoring models for different types of credit, or a generic model developed
by a credit scoring company.
This information is adapted from "Bound for Good Credit" published by
the Federal Trade Commission.
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