Understanding credit reports and scores

Understanding credit reports and scores

A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person, which is the likelihood that the person will pay his or her debts. A credit score is primarily based on credit report information, typically sourced from credit bureaus / credit reference agencies.
Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.

In the U.K. there is much academic research into credit scoring. Experts from banks, academia and government agencies gather bi-annually at the "Credit Scoring & Credit Control" conference in Edinburgh.

The most popular statistical technique used is logistic regression to predict a binary outcome such as bad debt or no bad debt. Some banks also build regression models that predict the amount of bad debt a customer may incur. Typically this is much harder to predict and most banks focus only on the binary outcome.

Credit scoring is closely regulated by the Financial Services Authority. Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, government departments, employ the same techniques. Credit scoring also has a lot of overlap with data mining, which uses many similar techniques.

In the United States, once every 12 months, each person is entitled to one free credit report from each of the three nationwide consumer credit reporting companies: Equifax, Experian and TransUnion.

The Government of Canada offers a free publication called Understanding Your Credit Report and Credit Score. This publication provides sample credit report and credit score documents with explanations of the notations and codes that are used. It also contains general information on how to build or improve credit history, and how to check for signs that identity theft has occurred. The publication is available online at http://www.fcac.gc.ca, the site of the Financial Consumer Agency of Canada. Paper copies can also be ordered at no charge for residents of Canada.

International issues
Credit history is typically local to one country. Even within the same credit card network information is not shared for different countries. For example, a person who has been using Visa credit cards issued by banks in China or Canada for many years who moves to the United States and immediately applies for a Visa will not be approved because of lack of credit history. However, bringing in evidences of good credit history from the previous country of residence will greatly help. Examples of such evidences are utility bills or credit card statements for the past couple of years.

Bibliography
On the history and origins of credit reporting, see Born Losers: A History of Failure in America, by Scott A. Sandage (Harvard University Press, 2005), chapters 4-6.