When You Use Credit Scores

Creditors have been using credit scoring to make credit decisions for several decades. Most of the older credit scoring systems were developed for internal use by a single creditor. In order to comply with Regulation B's requirements for consideration of the applicant's age in a credit scoring system, systems had to be developed using sound statistical techniques. The systems also had to be developed using the creditor's own empirical data or validated using the creditor's data.

Systems that do not consider age are not subject to the definition contained in Regulation B. The development and use of credit bureau scores has been possible because the applicant's age is not considered as a factor in the score. Instead, the score is based only on information about credit performance in the applicant's credit bureau file. The scores can be used alone or in conjunction with other information about or from the applicant.

The dramatic increase in the use of these scores is causing concern among some consumer advocates. As is the case with most statistics, consumers don't understand them and are intimidated by the use of statistics. In fact, many loan officers feel the same way.

Consumer advocates are concerned that using credit scoring to make credit decisions will allow an increase in discrimination through disparate impact. Using credit scores limits flexibility in underwriting. Consumer advocacy groups have filed lawsuits against both Freddie Mac and Fannie Mae to limit the use of credit scoring.

What all this means is that you should have a high level of confidence that your institution uses credit scoring in a way that promotes sound and fair credit decisions. To develop this confidence, take the following steps in your audits.

Look at all credit score overrides.
An override is a decision that is not consistent with the credit score. The override may be to approve an applicant with a low score or to deny an applicant with a qualifying score. Overrides would also include underwriting that differs from the standard set for that customer's score range. Overrides may form a pattern of disparate treatment. Any override should be documented and explained. If not, you could have a problem.
Review defaults, delinquencies, and slow pays.
Compare these to the prediction of the credit score at application. If the scoring system works properly, any payment problems should have been predicted by the system. Significant inconsistencies may result from failure to understand the scoring system or failure to use it consistently.
Examine the reasons for denial that the credit scoring system identifies.
The adverse action reasons produced by the system can give you a snapshot of the factors the system considers and the weighting given to those factors. These are statistically developed and the rationale can be confusing. However, you can also learn about underwriting issues from the factors used in the system.
Review adverse action notices to be sure the reasons given reflect reasons from the credit score.
Credit scores may be the exclusive reason for denial, or the score may be the cause for denial when taken in conjunction with other reasons. Your denial notices should reflect reasons from the credit score when the score played a role in the denial.
Evaluate appropriate uses for credit scores.
Compare your loan products with the instructions developed by Fannie Mae and Freddie Mac for use of credit bureau scores in underwriting. Their underwriting systems are developed using nationwide credit patterns. You need to verify that these patterns are appropriate in your market and for the products you offer. If there are significant differences, you should consider whether and how to make adjustments to the nationwide systems.