What’s in a Number? The Rise of the Credit Score Over the Centuries
A three-digit number holds tremendous power in today’s society. That number, known as a credit score, can determine whether someone is approved for an apartment, loan, or credit card. It can decide what interest rates and deposits they pay. It shapes everything from insurance premiums to employment decisions. In many ways, it represents an individual’s financial identity.
But credit scores have not always existed. Behind that simple number is a complex history intertwining lending practices, statistics, and information technology. Join us on a journey through time to understand the origins of the mighty credit score.
Early Credit in Colonial America
Long before credit scores, small, agricultural communities relied on informal personal relationships to facilitate lending. Store owners allowed regular customers to purchase goods on credit and pay them back later. It was a simple transaction among neighbors who knew and trusted one another. However, as the populations in port cities like Boston, New York and Philadelphia grew more diverse and mobile in the colonial era, early forms of credit reporting began to emerge.
The First Credit Agency Opens Shop
In 1841, a successful businessman named Lewis Tappan established the Mercantile Agency in New York City. This was the first credit reporting service in the United States. Tappan deployed agents around the country to gather financial information about businesses seeking loans. His credit reporters recorded facts about companies’ history, ownership, operations, assets and liabilities. This data helped banks decide whether merchants and traders seemed likely to repay borrowed money if offered credit.
Post-Civil War Growth of Consumer Credit
After the Civil War, consumer lending began to expand rapidly as more Americans bought goods on installment credit plans. Department stores allowed customers to take home purchases like sewing machines, furniture and pianos then pay for them in weekly or monthly installments over a period of months or years. This created a growing need for credit reporting data not just on companies but also individual consumers applying for loans.
The First Consumer Credit Bureaus
In 1898, Retail Credit Company formed in Atlanta as one of the earliest credit monitoring services focused on individual borrowers. Over the next few decades consumer credit bureaus sprouted up across the United States. These agencies kept files recording whether individuals paid their bills on time, borrowed to their maximum limit and honoured their debts. Lenders paid small fees to access these files when deciding whether to approve consumer credit applications.
The First Credit Scores Numericize Creditworthiness
Up until this point, credit reports simply provided a factual history of someone’s borrowing and payment behaviour. Judgement of creditworthiness was made in the mind of each lender. But in 1956, Bill Fair and Earl Isaac launched their startup Fair, Isaac and Company with a radical innovation. They created a mathematical model to statistically analyze details from credit bureau reports. This analysis translated details from a borrower’s credit history into a numeric score predicting their likelihood to fall behind on future loan payments.
The concept of a standardized “credit score” was born. Credit evaluations could now be made mathematically and objectively based on statistical probabilities instead of on the subjective judgement of individual underwriters. Applicants could be ranked and compared according to their numbers instead of just reading the tea leaves of their credit report narratives.
The FICO Score Becomes Today’s Standard
In 1989, Fair Isaac released a new formula for calculating credit risk that closely resembles the scoring system still used today. This model incorporated elements like payment history, debt levels, credit history length and types of credit used into a complex series of equations. The mathematical gymnastics resulted in a score ranging from 300 to 850 where higher numbers equate to lower credit risk. This three-digit encapsulation of consumer creditworthiness took the industry by storm and “FICO Scores” became the credit rating benchmark for decades.
Widespread Adoption in the 1990s
In the 1990s, FICO credit scoring rapidly became an integral part of mainstream lending across the country. The scores’ mathematical precision and seeming objectivity made them appealing to banks and other creditors. FICO and competitors like VantageScore gained widespread traction across all types of consumer lending from mortgages to credit cards to auto financing. Credit scores evolved from an esoteric financial concept to a key factor affecting loan decisions, sizes and interest rates.
The Modern Role of Credit Scores
Today, FICO and VantageScores play a central role in consumer finance all over the globe. Lenders rely on credit scores to set credit limits, mortgage rates, loan approvals and other terms. In many cases the numbers can determine whether a customer is able to acquire credit at all or becomes involuntarily shut out of the system. Beyond lending, credit scores now impact decisions for credit insurance plans, apartment rentals, and setting deposits for utilities and cell phone service. Poor scores can even follow people into the job market, sometimes causing applicants to get rejected by potential employers.
The numeric distillation of credit history has become a common yardstick to gauge financial responsibility, even defining people’s opportunities in areas far beyond borrowing. Many consumers remain confused about what exactly goes into a credit score and how the number is calculated. But behind that three-digit enigma lies sophisticated statistical modelling powered massive databases tracking individual payment behaviors.
Controversies and Criticisms
Despite their widespread adoption, credit scores also attract criticism and debate. Low-income, minority, and traditionally marginalized groups often score lower and face barriers to accessing credit at affordable rates due to historical socioeconomic disparities. Some argue that evaluating creditworthiness solely on quantitative factors like balances and payment history overlooks the realities that impact peoples’ ability to pay.
There are also transparency concerns around private companies’ refusal to publicly share details of their complex proprietary scoring algorithms. Consumers struggling with poor credit feel helpless to improve numbers derived from mysterious formulas and massive data sets beyond their control or understanding. People with limited credit history can find themselves shut out of opportunities for housing and lending no matter their actual ability or willingness to pay.
Ongoing Evolution
The concept of a credit score continues to morph in today’s big-data fueled economy. The scores themselves represent generations of evolving mathematical modelling for lending decisions, building on decades of credit history data collection. Yet controversy still swirls around their fairness as new technologies like machine learning promise ever more granular predictions using alternative data like social media posts.
As scoring systems continue advancing in precision and complexity, so do public concerns around privacy as intimate personal details become quantified, commodified and traded in the name of forecasting behaviours. The financial identities defined by our credit scores now shape critical aspects of our daily lives. The long evolution of those iconic three-digit numbers reveals deep linkages between information technology, statistics, and theories of financial responsibility.
