Call it the gatekeeper of credit. Its three digits can deny you a mortgage or establish your interest rate. And it's almost impossible to avoid in the lending world. That's because there's no credit score more trusted than the FICO credit score.
But there was a day when this ubiquitous rating wasn't around. Its creation was decades in the making by two scientists who believed computer-assisted credit evaluations could trump a handshake and a person's word. Now, 90 of the largest 100 U.S. financial institutions depend on the FICO credit score.
Its rise in the credit scoring world is not without controversy or stumbling blocks, however. In the beginning, many didn't buy into computer modeling and automation. And now, some challenge the score's dominance, while others question the score's accuracy.
"I get the idea of a credit score. It's a quick and dirty, easy way," says Pava Leyrer, president of Heritage National Mortgage in Michigan, who has seen the dawn of the FICO credit score over her 36-year career. "But I think there are some people who deserve a lower score and others who do the right thing in the wrong way and are penalized for it."
A long time coming
The FICO credit score wasn't hatched immediately after its parent company, Fair Isaac Corp., was founded in 1956 by William Fair and Earl Isaac. The pair had met a few years earlier while working at the Stanford Research Institute, developing ways to use computers to improve military decisions. They left Stanford under mysterious circumstances and decided to apply their research to the business world.
"Either they quit or got fired -- nobody really knows," says a source close to the Fair family who requested anonymity for security reasons. "But Bill Fair and Earl Isaac got good at computers at a time when very few people knew how to use them."
Working on a borrowed computer from Standard Oil of California during off-peak hours, Fair and Isaac began writing computer programs that could calculate scores that predicted behavior. Despite the innovation, their invention was slowly received.
They pitched the system to 50 major lenders in 1958. Only American Investment bought it. Montgomery Ward, the department store, followed five years later. And in 1970, the company signed up its first credit card issuer, Connecticut Bank and Trust. The company also developed a computer-automated system to process credit applications that nearly "killed the company," says the source.
"The idea of trusting a machine was pretty radical then," the source says.
Finally, Wells Fargo adopted the credit application software in 1972. The mid-'70s saw FICO expand into Europe as well as create its first score that predicted credit risk of existing customers for Wells Fargo.
"William Fair once said, 'We started the business in '56. By '75, we thought it would live,'" says the source.
In 1979, the company began working on a vision to create a general credit score generated from reports supplied by the major credit reporting bureaus. It would take 10 years before that vision came to fruition.
The score that changed it all
In the 1980s, FICO was creating custom scores for lenders based off credit bureau data. It also developed a score that helped prescreen potential borrowers from a consumer database at the credit bureaus for a lender's marketing efforts.
"That worked pretty well," says Anthony Sprauve, spokesman for myFICO.com, the consumer education division of FICO. "And then the light bulb went off: Can we take the credit report and from that, make a general credit risk score?"
FICO did that in 1989. The first general-purpose credit score based on Equifax credit reports debuted. Two years later, TransUnion signed up, and by 1991, the FICO credit score was available at all three credit reporting agencies.
"It was the first score that had transcended the three national credit bureaus," says Sprauve.
By the mid-'90s, after Fannie Mae and Freddie Mac's endorsements, the FICO credit score became the credit score of choice. The company now boasts that 90 percent of credit scores purchased by lenders come from FICO.
"It's critical in this industry," says John Stearns, a mortgage banker with American Fidelity Mortgage in Wisconsin. "For the most part, the scores are accurate, a good reflection of what has been going in a consumer's credit history."
FICO's legacy: The good, the bad and the ugly
FICO's dominance in the credit scoring industry isn't without its critics. Its greatest competition comes from the credit bureaus themselves, which provide the much-needed credit histories to produce the FICO score. In 2006, the three credit bureaus banded together and created a new credit score called the VantageScore as an alternative to the FICO score.
FICO struck back in 2007 with a lawsuit claiming a long list of infractions against VantageScore Solutions LLC and the three credit reporting bureaus. In court papers, FICO said its share of the credit scoring market had fallen a whopping 4 percentage points to 74 percent since VantageScore entered the scene. FICO eventually dropped the suit in 2011 after courts ruled in favor of VantageScore.
"FICO and the bureaus, the simplest way to describe it is as a cooperative relationship and a competitive relationship," says Sprauve, who noted that the credit bureaus sell the FICO scores to lenders, while FICO has no direct relationship with lenders. "We need the bureaus very much in partnership on the FICO score."
Consumer advocates and some in the lending industry have also questioned the accuracy of FICO credit scores. Leyrer notes that the FICO credit score leaves no room for nuance. For example, a person with a bankruptcy could have a similar score as someone who has many late payments, but no collections.
"I'll take a slow pay over a no pay every day," she says. "I've seen people with scores in the low 700s I would never lend a dime to. And I've seen people with scores in the 600s who I would loan my own money to."
The FICO credit score, among other credit scores, also has shown racial disparities, with minorities having lower overall scores, says Chi Chi Wu, an attorney at the National Consumer Law Center. She also notes that several studies show that many consumers' low scores are because of unexpected life events that affect their ability to pay bills. But once they get back on their feet, they are a good credit risk.
"The system doesn't do a good job distinguishing those folks from those who may have difficulty managing credit," she says.
Still, the FICO credit score isn't static. The latest FICO credit score is the eighth generation of the original score that Equifax first used in 1989. The company has also tailored the original for specific credit types, such as credit cards or auto loans. There are 53 FICO credit-risk scores being used by lenders today.
"We like to say that we never stop updating the models," says Sprauve. "We want to make sure the model best reflects current consumer habits, the kinds of credit products offered and any changes or improvements in credit bureau data."
The newest version ignores collections accounts under $100, de-emphasizes authorized user accounts and isolated late payments and is more sensitive to high credit card balances. The company is now looking into how loan modifications and natural disasters may affect consumers and their credit. A new, better iteration of the FICO credit score may come out of that research.
"They are scientists," says Wu. "They do think about these things."
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