Credit Scoring System is a scheme, which enables creditors to assess creditworthiness of the borrower on the basis of certain factors. Credit Scoring Systems vary from creditor to creditor. One of the most widely used credit scoring systems is FICO (Fair Isaac Credit Organization) score.
FICO score is a measure of credit risk used by the credit reporting bureaus. A credit scoring system assembles points for each factor that assist to anticipate the creditworthiness of the borrower.
The total number of points determine the credit score of the consumer. Credit score plays a crucial role in deciding the creditworthiness of a consumer.
Development of credit scoring model
At the time of processing Credit Scoring System, the creditor analyses the samples of it’s customers and identify the characteristics that relate to creditworthiness.
After studying the sample, creditor assigns a weight against each of these factors to determine the creditworthiness (good credit risk or bad credit risk) of the person.
Each creditor may apply its own formulated credit scoring system. It should be noted that under the Equal Credit Opportunity Act, no credit scoring system should contain the features like sex, race, marital status, national origin or religion as factors. Creditors are permissible to use age of the person.
It should be reminded that the process of evaluation of scores under a particular credit scoring model differs from creditor to creditor.
Benefits of applying credit scoring model
Credit scoring model helps the creditors to ascertain the creditworthiness of a loan applicant. It also facilitates to make decision faster, impartially and with more precision.
Automated credit scoring system: It is a proprietary software, normally used by banks to ascertain the creditworthiness of small businesses and their owners.
The three leading consumer credit bureaus have developed credit scoring systems that are designed to make it easier for financial establishments to assess the loan applications. The credit scoring system apportions points for each piece of relevant information and eventually produce credit scores.