Ditching FICO isn't the answer

Liz Pulliam Weston is an award-winning, nationally-syndicated personal finance columnist.

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TESS VIGELAND: While FICO credit scores are a less than perfect system, personal finance author Liz Weston says that lending used to be a lot more unfair before credit scores leveled the playing field.


Liz Pulliam Weston: The FICO credit scoring system can be baffling, capricious, illogical and unfair. It's also a huge improvement over the credit system we used to have. In the 50s and 60s most credit decisions were made by a banker.

If you happened to look like him -- white, male, fairly affluent -- your chances of getting a loan were much greater than if you didn't. Whole inner city communities found themselves rejected from mortgages and other loans. Women could often access credit only through their husbands, with no right to loans or credit cards in their own names.

The revolution in credit availability didn't really begin until the invention of the FICO scoring formula in the 80s. Lenders had been experimenting with credit scores since World War II, but typically based their formulas on the relatively small group of customers they'd already approved for credit. Lenders didn't know how people who weren't white, male and affluent might behave. So they remained cautious about extending credit outside that small universe.

Engineer Bill Fair and mathematician Earl Isaac answered that question by using a vastly larger database -- the millions of credit files stored and the three major credit bureaus. Fair-Isaac came up with a formula based on all that information that promised to predict with far more accuracy who was likely to pay their bills and who wasn't.

The FICO formula doesn't consider race, gender, or even income. All that matters to FICO is how you've handled credit in the past, particularly the recent past.

Armed with FICOs, lenders became much more willing to extend credit across the board. Having access to credit gave millions the chance to own homes, pay for educations and start small businesses -- people who might never have had that opportunity in the pre-FICO era.

Perhaps inevitably lenders took things too far. At the peek of the lending bubble, many lenders stopped looking at anything but FICO scores. They stopped using other measures of risk, such as the borrowers' existing debt loads and their capacity to pay new debt that they were taking on. The result of lenders irrational exuberance for the FICO score is the financial crisis we're experiencing now.

But ditching the FICO isn't necessarily the answer. Despite numerous attempts, nobody's come up with a better formula that lenders are actually willing to use. Anyone who wants to educate herself can figure out ways to improve and protect her score. Knowledge is still power. And I'd rather have that power at least partly in my hands, than solely in the hands of some banker behind a desk.

Vigeland: Liz Pulliam Weston is a personal finance columnist for MSN and the author of "Your Credit Score."

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