Did You Know the Equal Credit Opportunity Act addresses the use of credit scores?
The Federal statute known as the Equal Credit Opportunity Act, or “ECOA,” is the law that forbids discrimination on the basis of race, color, religion, national origin, sex, marital status, age or acceptance of public assistance. It applies to all aspects of public life in America, including lending. If you look the next time you visit a bank branch or credit union, you’ll see signs summarizing your rights under the ECOA.
And while protections from discrimination are the most commonly known provisions of the ECOA, few people realize that the Act also addresses credit scores. The ECOA does not endorse or require the use of credit scores by lenders, or any other party. But, it does define what is a “credit score” and sets the standards that scoring systems must meet in order to be considered empirically derived, which is important because it allows for a larger breadth of information to be considered.
A credit score, according to the ECOA, is a system that evaluates creditworthiness mechanically based on attributes associated with an applicant. In order for a credit scoring system to be considered empirically derived, it must be constructed using accepted statistical methodologies, and it must also be revalidated periodically to maintain its predictive abilities. What all of this means in English is the scoring model must be built using scientific methods and it must actually work.
In the world of credit scoring models, to “work” means a model must properly rank order the consumers it evaluates. Rank ordering is the formal term for assigning higher scores to people who are good credit risks (i.e., those who are most likely to repay their debts on time) and lower scores to people who are poorer credit risks. Credit scoring models which base their calculations on credit-file data maintained by the three major credit reporting companies (CRCs)—Equifax, Experian and TransUnion—have been recognized as empirically derived for more than 25 years. Continual validation by model developers has proven how effective these CRC-based scores are at rank ordering, which is why they have become so ingrained in lenders’ automated underwriting and risk assessment processes. CRC-based scoring models have also been recognized as fair and impartial under ECOA.
Why does this matter to the average consumer—even one who is not subject to the other protections of the ECOA? It means that whenever a lender uses a CRC-based credit scoring model to make a decision about your credit application, it is using a tool that is unbiased and is not based on flawed assumptions.
This is especially comforting considering the amount of media coverage that is focusing on the potential use of social media activity to measure credit risk. The legitimacy of such data under ECOA is far from established and as a result, there is little chance that social media data will be used to influence your credit score anytime soon.
It also matters because CRC-based credit scores continue to be the most commonly used of all scoring tools, and there’s nothing to suggest their use will diminish in the future. The ECOA requirement that credit scoring models be continually revalidated means that lenders must test them and prove that they continue to work.
VantageScore Solutions is unique in the credit scoring industry because we publish the results of our annual model validation on our website, for all to see. The most recent validation report is available here.