The Credit Score Role for Lending

Have you ever seen an advertisement online that encourages you to apply for a credit card or loan, with a credit approval decision in as little as 30 seconds?  Technology has given the world so much, and in particular- the financial services industry has really taken to automated decision making technologies. 

Lenders have relied on credit scores to determine whether or not an individual should be extended credit since the 1950's.  A credit score is a prediction of an individuals ability to repay the money they borrow based on their previous payment history and other factors.  When you see offers for credit that provide instant credit approval decisions, the decision is being made automatically based on your credit score- and very little else.

Advantage of Credit Scores in Terms of Applying for Credit

While many individuals and small business owners may feel their credit worthiness should involve more than a number they're given by a credit model formula, there are many advantages to using credit scores in order to determine credit worthiness for both lenders and consumers.

Before credit scores were relied on almost primarily for approval for a small business loan, the process could take as long as two weeks to determine whether a small business owner qualifies for a loan or not.  In this business world, two weeks can make a huge difference in your ability to keep up with the competition or expand your business for increased profitability.  Two weeks can actually result in missing out on many opportunities that could have been successful had a business only had access to the funds of the business loan.  With the use of credit scores, a lender can determine credit worthiness for a small business owner in under an hour.

With credit scores, there is reduced subjectivity involved with the approval of a loan.  Before the use of credit scores, friends of loan processors might have an increased probability of being approved for a loan, regardless of their actual credit worthiness because subjectivity comes into play.  Human judgment is affected by  many factors that a mathematical score is not.  Lenders can use scores to be sure they apply the same set of standards to all applicants, regardless of whether the approving loan officer is friends with an individual applying for the loan, or regardless of personal characteristics that might affect a human's judgement- including race or gender of the applicant.

Alan Greenspan, the U.S Federal Reserve Chairman made a speech to the American Banker's Association in October of 2002, stating "credit scoring technologies have sharply reduce the cost of credit evaluation and improved the consistency, speed, and accuracy of credit decisions."

Credit Scores Advantages for Account Management Purposes

In addition to the advantages of using credit scores for applying for financing, there are benefits related to account management.  Lenders can use credit scores for the collection of loans, for decisions related to modifications, line management, recovery strategies- and then are able to make the right decisions because a score removes bias.

Credit scores also provide a tool for assessing the profitability of account relationships.  Lenders can establish an initial credit limit based on the score, as well as increases to those limits based on changes to an individuals credit score.  Fraud detection has improved due to credit scoring and reporting.  More people are able to obtain financing from lenders, while lenders are willing and able to provide financing to more diverse groups of people in a profitable way based on credit scores- meaning, higher risk applicants are not always denied lending, but rather can obtain financing at higher interest rates.