Credit scoring model is used by credit reporting bureaus primarily for the purpose of determining the credit scores and creditworthiness of the consumers. On the basis of certain factors, Credit Reporting Bureaus use different scoring models for different purposes. These days, individual can obtain his own score with ease.
Score calculation technique
Credit scoring models calculate the score on the basis of the information contained in individual’s credit report. Credit applications along with individual’s occupation and length of employment are also taken into consideration while computing the credit score of an individual.
Credit scoring model supported by Fair Isaac and Company considers individual’s payment history which accounts for about 35 % of the individual’s total credit score.
Payment history of an individual shows various accounts like mortgage loans, credit cards, and retail accounts. Some of the other factors normally considered while calculating credit score are lawsuits, collections and foreclosures.
Types of Credit Scoring Model
Credit score assures the credit worthiness of the consumer. There are basically two types of credit scoring models. One is Statistical Scoring Model and the other is Judgmental Scoring Model.
1-Judgmental Scoring Model: A judgmental scoring model is primarily based on traditional standards of credit analysis. Judgmental Scoring Model considers factors like bank and trade references, payment history, credit bureau ratings and financial statement ratios to produce the total credit score of the individual. Judgmental scoring model is comparatively easier to interpret and is almost free from ambiguity.
2-Statistical Scoring Model: Statistical model works in almost the same way as judgmental model. Statistical model considers many factors at the same time. This model analyzes multivariate (any procedure which involves two or more variables) correlation (A reciprocal relation between two or more things) to assign statistically derived weights used in the model. The factors are normally obtained from individual’s credit files and also from the credit bureau reports. Statistical Scoring Model can also be described in terms of a scorecard, a pooled scorecard, and a custom scorecard . A scorecard applies data from one firm, whereas a pooled scorecard applies data from more than one firms and a custom scorecard mixes the data acquired from both the statistical model and judgmental model.
Objectives of Credit Scoring Model
The primary objective of Credit Scoring Model is to ascertain an overall risk score based on certain guidelines.