To understand how or why credit exists and it’s famous (or infamous) 3-digit number that seems to rule a significant portion of your adult life, we need to start at the beginning.
Since the dawn of time, people love to trade things. Even during caveman times, someone always had something somebody else wanted or needed. But more often than not, the person wanting something didn’t have a sufficient means to properly compensate the other person.
Clubs for Food
Crugh, for example, is a caveman who makes really awesome clubs that can be used for hunting, but Crugh doesn’t know how to hunt. Kror on the other hand, is a well know hunter but doesn’t know how to make clubs. Crugh is willing to trade his clubs with Kror, but only if Kror gives him food from the latest hunt. Even though Kror agrees, Crugh isn’t entirely sure if Kror is a caveman of his word and asks others how reliable is Kror at making good on his promises.
This is how ‘credit’ began and is still the fundamental cornerstone of the credit system today, how well people hold up their end of the bargain when something was traded. That something in most cases is money.
The First Credit Score
Before credit scores were invented in the 1950’s, the decision whether to lend you money was primary based on your reputation within your local community. While this system worked well for some, many were left out because they either weren’t very well known in their community, weren’t liked in their community, or the loan officer was just having a really bad day and simply said “no”. People wanted a better system, a system that was fair and impartial to a grumpy loan officer.
Enter Bill Fair.
Bill Fair was an engineer who teamed up with Earl Isaac, who was a mathematician and founded Fair, Isaac and Company in 1956. Their goal was to create a standardized, impartial credit scoring system. The duo began selling the scoring system to people within two years of founding the company. Today, the company lives on under the name; FICO.
The Current Credit Score
The credit scoring system we all know of today made its debut in 1989 and quickly became the industry standard. Your credit score dictates whether you’ll be approved for a loan and the interest rate you’ll pay for that loan. It determines whether you’ll purchase a home, a car, or any other significant purchases you’ll make in your lifetime.
The current credit scoring system is a 3-digit numerical value between 300 and 850 and is generated by the following factors which are weighted in order of importance; payment history, amounts owed, length of credit history, types of credit used, and credit inquiries.
The natural course of evolution took place when someone realized what they knew of Crugh and Kror was important and they wanted in on the action, enter Snuga. Snuga made it a point to know something about everyone in the group because she knew that information would prove to be valuable.
This is essentially how credit bureaus got their start. Someone needed to store all of that information that was being used to generate a credit score. Equifax is the oldest of the 3 major bureaus, dating back to 1899. Equifax used to collect rather naughty bits of information on people such as marital affairs and political beliefs. This ultimately led to the implementation of the Fair Credit Reporting Act which standardized the type of information that could be collected.
TransUnion was founded in 1968 as a leasing organization for the railroad. Not long after being founded, the company was acquired by the Credit Bureau of Cook County and was reorganized to be the company you know of today.
Last, but certainly not least, Experian is the new kid on the block as it was founded in 1996. See what I did there? New kid on the block, and found in the 1990's. Okay, don't judge me for trying.
Each bureau has slightly different ways they go about collecting their information, which makes it even more of a headache to stay on top of things as each bureau could have different information included in their file.
Credit: A Necessary Evil?
For most of us, credit is necessary to help facilitate large purchases like a house or car. But is it evil? The short answer is no. It’s not evil because credit is nothing more than a natural evolution to how people interact with others when it comes to trading things. There will always be someone who has something that someone else wants or needs. In today’s society, that’s usually money. Credit is simply a tool that can be used to enhance your buying power.
For example, you have saved up $5,000 to buy a car. You go out and buy a car that’s a bit older and needs some TLC. Each month you must spend $200 just to keep it on the road and unfortunately, it breaks down 6 months later. Now you’re out of $6,200 and no way to get to work. Here’s how credit enters the picture.
That same $5,000 is used as a down payment on a newer, more reliable car that has a warranty. You pay $200 per month as a car payment and own the car once all payments have been made. It doesn’t nickel and dime you and never leaves you stranded trying to figure out how to get to work.
While the credit system is not without faults, it’s not vulnerable to the whims of a grumpy loan officer making arbitrary decisions based on partial information. Now that you know the origins of credit and credit scores. Be sure to check out other #WizFAM articles about credit.