Credit scores have become a ubiquitous and valuable component of lending and borrowing. They revolutionized underwriting by streamlining the process and permitting centralized lending, where a policy can be deployed with ease across a bank’s entire network of branches. But the one question that lenders that use scores, or consumers who are trying to improve theirs rarely asked is, “What is a credit score actually designed to do?”
Depending on whom you believe, credit scores were created to do a few different things. Some say they are designed to predict default, bankruptcy or some other form of non-performance. Others believe that credit scores are designed to predict whether or not you can afford the loan or credit card for which you’ve applied.
Some point out that credit scores have served to end some forms of racial, religious or gender discrimination (both intentional and unintentional) that were not uncommon during the earlier era of manual underwriting.
To the cynical bunch, however, credit scores are designed to reward people for being in debt.
All of the aforementioned answers are wrong. Credit scores aren’t “designed” to do any of those things.
All credit-scoring systems have what’s formally referred to as a “performance definition.” A performance definition is the model’s stated design objective or principal intended purpose. And although credit scores certainly may do more than just assess consumer credit risk, there is a best practice for the use of credit scores (like using a butter knife rather than a steak knife to cut a steak).
Credit-bureau-based scoring systems — the models that are based on the data in one of your credit reports with the three major bureaus — are designed to predict the likelihood that you’ll go 90 days (or more) past due on any obligation in the 24-month period after your score has been calculated. That is their performance definition, and that is why these credit scores can take a considerable hit if you’ve gone 90 days (or more) past due on a credit obligation.
Now, this limited performance definition doesn’t mean that such credit scores are unable to help predict the likelihood that you’ll file for bankruptcy. It just means that these scores weren’t “tuned” to predict that particular outcome. But just like the butter knife and steak analogy, such scores may still be effective in measuring other types of risks.
This is also why your credit scores don’t take the same hit if you have an isolated 30-day late payment on your credit reports (especially relative to the hit you would take for a more severe delinquency, or even some form or evidence of default, like a third-party collection suddenly appearing on your credit reports). It’s also the reason why other incidents, like charge-offs, settlements, repossessions, foreclosures or other severely derogatory credit entries, tend to have the same, or very similar, adverse effects on your scores. Such events all represent accounts that are 90 days (or more) past due.
If you have low-level or no delinquencies on your credit reports, then you’ve proven to the credit scoring system that you’re not willing to go 90 days past due on anything, and your scores are rewarded as a result. However, if you do have a record of going 90 days or more past due, your scores will never be as high as they otherwise could be.
Disclaimer: The views and opinions expressed in this article are those of the author John Ulzheimer and do not necessarily reflect the official policy or position of VantageScore Solutions, LLC.
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