Credit scores can help determine where you live, the interest rates you are charged on loans and credit cards, and even how much you pay for car insurance. The algorithms that generate these scores have been developed over decades, and a person’s ability to manage their score can influence much of their financial life.
An entire industry is built around monitoring and managing credit scores, and advertising campaigns of the 2000s and then popularized the idea of trying to navigate the nuances of algorithms as part of maintaining personal finance health.
“I think of the FICO score as an algorithm, a highly predictive algorithm,” said Ethan Dornhelm, who leads analytical research and development for FICO. “It’s the one we develop from millions of anonymized credit reports. And we’re taking that algorithm and rolling it out to the credit bureaus. »
“It will be information such as what old loans you have had,” said Manju Puri, professor of finance at the Fuqua School of Business at Duke University. “Credit cards, your lines [of credit], were you late? Have you failed? All of this information is taken into account and aggregated into a credit bureau score. »
When it comes to algorithms, those that score credit tend to be relatively simple, said FICO’s Dornhelm.
“If I had a consumer’s credit report in front of me, I could actually calculate their FICO score by hand in about 10 minutes,” he said.
And after decades of consumer education, many people feel like they know how to navigate the algorithm, even if they don’t consciously do so.
Laura Ericksen, a retired academic advisor in Edina, Minnesota, said years of paying bills on time and being careful with credit kept her score “safely above 781.”
“It gave me a better rate when I bought my house. So it costs me less money to live. And I can live in a nicer area than if I had had a higher interest rate. and that I had to spend less money on a house.
Although she’s pretty settled and comfortable, with no major shopping plans ahead, Ericksen said she stays on top of her numbers because they affect other aspects of her life as well.
“I just watch my credit scores because it affects my interest or my rate on my [auto] Insurance … you get the best rate if you have a good score. “
In addition to FICO, there are other credit scoring models, such as the VantageScore, and banks and individual lenders often have their own teams of data scientists and their own algorithms. Different models will assign different levels of importance to components of a consumer’s credit report, which is why people can have multiple scores.
“All access to formal credit markets was usually based on obtaining a score from a credit reporting agency,” said Manju Puri of Duke University. “And so people who have credit histories or thin credit records, they have a hard time… getting a mortgage or other things because you don’t have a score.”
And it can create or exacerbate economic inequality, said Aaron Klein, a senior fellow at the Brookings Institution. Klein moderated a panel at the end of 2021 consider whether the credit score should be improved — or eliminated.
“Most people who default on a loan do so because of an urgent circumstance, such as a medical disaster, death in the family, divorce, or job loss. These things aren’t necessarily well modeled by whether or not you’ve been late on a bill in the past,” Klein said.
“My car insurance rate was lowered, despite a less than stellar driving record, because I had good credit,” he said.
In the late 2000s, a series of advertisements about a hipster musician with bad credit helped popularize the idea of regularly checking your credit report.
Gaming YouTube channel “Shameless Nerd” has an 8.5-minute video tracing the history of the ads and what happened to the musicians involved.