Does Credit Scoring Work?
Credit-scoring models are extremely complex. Even if you had the time, desire, and mathematical genius to validate the scores, you would not be allowed to. Credit-scoring models are top-secret. This may lead you to wonder if they are fair and accurate. In fact, this question has been raised frequently throughout the history of credit scoring.
Are They Discriminatory?
One of the major criticisms of credit scoring is that nobody except the scorer understands how they work. Because of this, consumer advocates worry that the scores could be discriminatory, or just plain useless. According to Craig Watts at the Fair Isaac Corporation, government regulators have taken a look under the hood of the FICO credit score. They have seen how the model works, and which factors pushed the score up or down. Regulators did not find that the models were discriminatory.
It is difficult to determine exactly how credit-scoring models do what they are supposed to do. Nevertheless, market forces have shown that credit scoring does something right. Lenders and insurers, even though they may not understand the exact process, are willing to pay for credit scores and base decisions on them.
While the models themselves may not be discriminatory, this subject continually sparks heated debate. It seems that some minorities may appear less favorable under certain scoring models. Is this because the model is discriminatory, or because historical discrimination still affects society? There are a number of studies on each side of the debate, all of which claim to provide a definitive answer. Because credit data is used in more and more places (like insurance scoring, for example), this debate is sure to continue.
Are They Accurate?
While regulators may say the models are not discriminatory, another question remains: does a credit score accurately predict whether or not a borrower is likely to fall behind on payments? To answer this, you may expect that lenders would want to look under the hood just like regulators have. They might want to see how the various inputs affect the output.
The models are top-secret, and lenders are not allowed to look at the nuts and bolts. However, they continually use credit scores as a major part in their lending decisions. Why would this be? According to the Fair Isaac Corporation, lenders use the FICO credit score because it works. They have tested and retested this score against their own internal decision-making process. They found that the score seems to work, and that's all that matters to them.
