Credit Scores: Development, Use, and Policy Issues
CRS Report for Congress
Development, Use, and Policy Issues
Government and Finance Division
Credit scores and credit scoring systems were created to provide a tool to evaluate
the creditworthiness of prospective borrowers. There are a variety of credit-scoring
statistical models, each employing complex formulas to generate credit scores. First
used for certain forms of consumer credit (auto loans and credit cards), credit scoring
came into common use in the mortgage lending business a decade ago. More recently,
credit scores are being used by non-credit-related industries, such as insurance, to
evaluate risk and predict behavior. The use of credit scores has streamlined the
decision-making process of the lender which can result in more rapid access to credit for
the consumer. At the same time, pervasive use of credit scoring has raised concerns
about consumer awareness of and access to credit scores as well as the consistency and
accuracy of scoring systems. The 108th Congress held a series of hearings on renewing
the Fair Credit Reporting Act (FCRA)state law preemption provisions dealing with the
exchange of credit information. The hearings provided a forum for discussions on
related consumer protection issues. On December 4, 2003, legislation was enacted to
permanently extend the federal preemption provisions. The Fair and Accurate Credit
Transactions (FACT) Act of 2003, P.L. 108-159, also addressed a wide range of
consumer protections including access to credit report and scoring information and the
accuracy of that information.
This report gives background on the concept of credit scoring and the issues raised
by the pervasive use of credit scores. An overview of the FACT Act provisions dealing
with credit scores and credit reports is also provided. This report will not be updated.
The concept of credit scoring was developed several decades ago to measure the risk
of delinquency or default presented by a consumer seeking credit. A research firm, Fair,
Isaac & Company (FICO), developed the first scoring system, and the “FICO” score
remains a credit industry standard. The score, usually a three digit number between 300
and 900, is used by a lender to rank a potential borrower. The higher the score, the lower
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the risk. This ranking helps to determine whether a consumer qualifies for a loan, the
amount of the loan, and the loan rate.
During the 1990s, credit scores began to be widely used by the mortgage industry.
Lenders attest to the value of using credit scores. They state that scores provide a fast,
accurate risk assessment which can streamline the lending process. By one estimate
credit scores are a determining factor in 90% of all U.S. consumer credit decisions.1 More
recently, non-credit-related businesses, including auto and homeowners insurance, have
found credit scores to be a useful rating variable. Increased reliance on credit scores by
lenders and other businesses raises consumer issues such as access to scores, awareness
and understanding of scoring systems, consistency of scores, and accuracy of scores.
Credit scores are not easily explained. The score provides a picture of the
consumer’s credit history and worthiness at one point in time (when the score is
calculated). Lenders and other businesses may use their own credit scoring model,
different scoring models for different purposes, or a generic model developed by a credit
scoring company. Credit scoring models use complex statistical formulas, and the models
vary among creditors and for different types of credit. Technological advances have
allowed a large number of predictive variables to be rapidly evaluated during the
calculation of a credit score. Models can be solely based on information from credit
reports, or the model may include other information found on the credit application, such
as income and employment history. The Equal Credit Opportunity Act2 prohibits certain
characteristics from being used in a credit scoring system. These include race, sex,
marital status, national origin, and religion. Only recently have scores been made
available to the individual consumer. A number of companies now offer to disclose credit
scores and provide explanatory information, usually for a fee.
Mortgage lenders primarily rely on credit scores generated by the three national
credit reporting agencies (bureaus): Equifax, Experian, and Trans Union. The three
bureaus independently collect data on individual consumers and use this information to
create a consumer credit report. The Fair Credit Reporting Act (FCRA)3 provides
consumer protections to deal with inaccurate and inappropriate use of personal
information. The FCRA sets out requirements for all consumer reporting agencies and
users of credit information. Four categories of data are collected for a credit report:
personal information, credit history, public record information, and inquiries.4 Data in an
individual’s credit report will then be fed into a credit-scoring model and used to calculate
a credit score. Credit report files are continually updated as the bureaus receive new
information. Since they work independently, the three bureaus do not necessarily collect
identical information, and the three use various models. Therefore, not only can credit
scores frequently change, but each agency can generate a different score for the same
1 “Credit Scores And Mortgage Lending,” AARP Public Policy Institute. IB Number 52. P.1.
2 Pub. L. 93-495, tit. 5, 88 Stat. 1520, 15 U.S.C. 1691 et. seq.
3 Pub. L. 91-508, tit. 6, 84 Stat. 1128, 15 U.S.C. 1681 et. seq.
4 Inquiries are requests by a creditor for a copy of an individual’s credit report.
Scoring models generally evaluate five factors from a credit report when calculating
a credit score. Different weights can be assigned to each factor for different types of
credit applications. The five are payment history, amounts owed, length of credit history,
new credit (accounts or requests), and types of credit accounts.
Payment history is usually a heavily weighted factor. Payment information on many
types of accounts is collected in a credit report. Accounts include credit cards, retail
accounts (credit from stores), finance company accounts, and mortgage loans. A
consumer’s timely payment of bills, such as phone or gas, does not influence this factor
unless a consumer’s account has been sent to a collection agency. Late or missed
payment information would include details such as how late, amount owed, and how
recent was the event. Also included in this factor are public record and collection items
including bankruptcies, foreclosures, suits, and wage attachments.
Amounts owed is also a significant factor in credit scoring. This factor evaluates the
amount of debt a consumer has compared to his or her credit limit. Is the consumer over
extended? Any amount owed on all accounts is considered, and different types of
accounts are compared. Outstanding debt is compared with the original loan amounts.
The length of a consumer’s credit history provides a credit track record. How long
have accounts been established? In general, the longer an individual has had a credit
history the better. An insufficient credit history — including no credit history — can
negatively affect a score.
Applying for new credit can affect credit scores. How many new accounts does a
consumer have? Requests for credit generate inquiries (requests by lenders to get a copy
of an individual’s credit report). Applying for too many new accounts can negatively
affect a score. Inquiries by creditors who are monitoring a consumer’s account or looking
at credit reports to make “prescreened” offers are not counted.
How many and what types of credit accounts an individual has affects one’s credit
profile. While it is generally good to have established credit accounts, too many or certain
types of credit accounts may affect a score negatively. Some scoring systems do not rate
loans from finance companies favorably.
The pervasive use of credit scoring has raised concerns about consumer awareness
of and access to credit scores as well as the consistency and accuracy of scoring systems.
Credit scores are a standard factor in consumer credit decisions and are increasingly used
as a rating variable in insurance underwriting.5 In addition, employers have used credit
scores to evaluate job applicants and landlords have used them judge prospective tenants.
5 For additional information concerning credit scores and insurance see CRS Report RS21341,
Credit Scores: Credit-Based Insurance Scores, by Baird Webel.
So credit scores are being used not only to measure a consumer’s credit worthiness but
also as a factor in the evaluation of a consumer’s financial stability, responsibility, and
potential risk. The use of credit scores in mortgage lending has generated most of the
legislative attention. The use of credit scoring in non-credit-related businesses has been
increasingly controversial — in part because the connection between credit scores and
insurance or renting is not obvious.
Until recently, the credit scoring industry did not provide consumers with access to
their credit scores. Public pressure and a 2001 California state law prompted wider
availability of credit scores nationwide. Still, many consumers’ first knowledge of the
existence and importance of credit scores comes as a result of not qualifying for a loan.
Consumer advocates state that more needs to be done to educate consumers about credit
scores, to make the scoring systems more transparent, and to provide consumers less
costly or free access to their scores.
The FCRA permits credit bureaus to charge up to $9.00 for a credit report and allows
additional fees for credit scores. For example, FICO scores have been available from
Equifax as part of a credit profile package for $12.95. A consumer is entitled to a free
report if the consumer was denied credit or was notified by an insurance company of an
“adverse action” based on information provided by a credit bureau. The consumer must
place a request within 60 days of either of those events. Consumers have been entitled
to free annual credit bureau reports upon request under state law in six states (Colorado,
Georgia, Maryland, Massachusetts, New Jersey, and Vermont).
A consumer can end up with a multitude of scores depending on the credit data used
and the scoring model. Scores are available from a variety of score providers and some
lenders (fees vary). In addition, the credit score the consumer pays for may not be the
score a particular lender used in the lending decision-making process. A consumer can
have a difficult time discovering what score was used; individual lenders or insurance
companies do not always provide this information.
Just as important as obtaining the score is understanding what it represents,
especially if a consumer wants to improve it. Consumer advocates argue that complete
disclosure of exactly what factors were considered and how they are weighted is required
to really understand a score. Full disclosure, they say, would also allow testing of scoring
models and formulas to determine how accurately they evaluate consumers. The
computations involved in scoring models are closely guarded proprietary information.
Score providers such as Fair, Isaac & Company have published some explanatory
information to help consumers understand scores, but they say to disclose more about
their model would hurt the company competitively. They say they would, in effect, be
giving away what they are currently selling.
Consumer advocates have argued that steps need to be taken to assure the same
credit information is submitted to each bureau to minimize the differences between the
credit reports generated. If the information filed with credit bureaus were more
consistent, then the scores calculated from their credit reports would vary less. Advocates
also backed better and more consistent reporting of positive credit information to enhance
the accuracy of credit reports.
In December 2002 the Consumer Federation of America and the National Credit
Reporting Association published a study of the accuracy of credit scores and credit report
information.6 The study was based on a survey of 502,623 archived credit files generated
by a request for the reports and scores from all three national credit reporting agencies.
The study found that scores from the three bureaus for a consumer varied substantially.
Many credit files had additional reports that did not belong to the consumer’s file and
many had conflicting information. The reports provided limited information to help
individuals understand their particular score. The study concluded that while many
consumers are unharmed by these findings, millions of consumers are at risk of being
adversely affected by inaccurate information and incorrect scores. The potential exists
for individuals to either be denied credit or be placed into a more expensive pricing range.
Consumers can take steps to ensure the calculations are made on accurate
information. Individuals can request their credit reports from all three major bureaus and
check for incorrect or obsolete information. Correcting mistakes can be costly, time-
consuming, and frustrating. The bureau has 30 days to confirm an entry with the
reporting creditor and must make changes to the credit report if the mistake is confirmed.
If a creditor fails to respond the entry must be removed. This may require a follow up
inquiry by the consumer to make sure correcting steps were taken. Therefore, a consumer
may need to begin the process well in advance of applying for credit to guard against an
adverse lending decision.
While correcting mistakes can improve a consumer’s score, this is not a guaranteed
outcome because the consumer does not know how a particular entry fits into an
individual scoring formula. In addition, scoring models may be based on more than the
information found in a credit report. For example, the model may include data from the
loan application such as employment history.
Congress established consumer credit protections with the enactment of several laws
dealing with specific credit practices, including the FCRA in 1970. The FCRA has been
amended to meet the developing needs of consumers for credit protections. Congress
continues to monitor the effectiveness of the FCRA’s provisions as the use of consumer
credit information grows. Complaints by consumers and criticism by consumer advocates
have drawn congressional interest to issues raised by credit scoring.
The 108th Congress considered issues raised by credit reports and credit scoring
during the debate over whether to renew FCRA state law preemption provisions dealing
with the exchange of credit information.7 A series of hearings held before the House
Financial Institutions Subcommittee and the Senate Committee on Banking, Housing and
Urban Affairs on the provisions evolved into a forum for discussions on a number of
6 “Credit Score Accuracy and Implications for Consumers”, a report by the Consumer Federation
of America and the National Credit Reporting Association, Dec. 17, 2002,p.47.
7 For more information on the preemption provisions see CRS Report RS21449, Fair Credit
Reporting Act: Preemption of State Law, by Angie A. Welborn .
consumer protection issues. Concerns included access to credit report and scoring
information and the accuracy of that information. Identity theft and financial literacy were
also addressed during the hearings. Legislation, the Fair and Accurate Credit Transaction
Act of 2003 (H.R. 2622), was introduced and passed to reauthorize and make permanent
national credit reporting standards. The FACT Act (P.L. 108-159) was signed by the
President on December 4, 2003. The law addresses a variety of consumer protection
measures that were raised during the hearings.8 Consumer advocates were generally
supportive of the improved consumer protections but were opposed to the permanent
Major provisions of the FACT Act address credit reports and scores. Title II of P.L.
108-159 deals with the use of and consumer access to credit information. Title II provides
consumers the right to request a free credit report from national consumer reporting
agencies (bureaus) annually. Consumer will place a request by mail, phone, or the
Internet through a centralized system established by provisions in the act. Consumers will
also be able to request reports from specialty bureaus, for example landlord or insurance
reporting services. Financial institutions that furnish negative information regarding
credit extended to a customer to a reporting agency are required to notify the consumer
concerned in writing. Credit bureaus must provide credit scores and key disclosure
information on how the credit score was derived (including factors that adversely affected
a consumer’s score) upon request. In addition, the bureau must include a statement
indicating that the information and the credit scoring model may be different from the
credit score used by the lender. A reasonable fee may be charged for providing credit
scores. Mortgage lenders must disclose the credit score used by the lender in connection
with a home loan and the key factors affecting the credit score to the home loan applicant.
No fee is authorized for this disclosure.
Title III addresses the accuracy of information. Title III requires the creation of
guidelines for furnishers of information regarding the accuracy and completeness of the
information they provide to consumer reporting agencies. Consumers will be able to
dispute the accuracy of information directly with the furnisher. In addition, new
procedures for addressing consumer complaints by the Federal Trade Commission (FTC)
and credit bureaus are created. A risk based pricing notice will be required when credit
is extended on terms “materially less favorable than the most favorable terms available
to a substantial proportion of consumers”from that creditor.
P.L. 108-159 requires the FTC to conduct a number of studies. One study will report
on the effects of credit scores and credit-based insurance scores on the availability and
affordability of financial products. The FTC will study improving the accuracy and
completeness of information contained in consumer credit reports. The FTC must
conduct a study on ways to improve the FCRA. In an effort to increase and enhance
consumer knowledge, the FACT Act establishes a financial literacy and education
8 For a detailed summary of the key provisions in the FACT Act, see CRS Report RL32121, Fair
Credit Reporting Act: A Side-By-Side Comparison of House, Senate and Conference Versions,
by Angie A. Welborn and Loretta Nott.