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The Basic Nature Of Credit Risk Scorecards

May 13, 2008
Since the dawn of paper notes, the financial capability and buying power of people have been significantly rated through credit risk scorecards. In the United States alone, almost all adults are very conscious of their own credit rating. This is because a person's credit rating will determine if he is a person with whom a bank may transact with in terms of loans. Not only in banks, but also in the acquisition of credit cards.

Credit risk scorecards are used mainly by financial institutions to know if a potential debtor is worth taking the risk. It will be unwise for any lender to lend money or any asset to a person whose financial power is doubtful. History is needed to have a data-driven approach before reaching a decision. With this type of scorecard, a creditor will see at a simple glance if the person is trustworthy. The information age is not like the olden times in which lending money can be based on verbal promise.

These ratings are normally gathered by credit bureaus. These organizations have a very vast amount of data that statistically show whether a person is worth lending money to or not. Every person's historical background in terms of finances are there in that database. The main problem is there are so many companies offering credit scores that it already borders to confusion.

Many of these credit reporting agencies use varying formulas that will show different results. These results are normally trademarked by these credit reporting agencies and are for sale. The people who buy these are people who have businesses who need to verify if the person they are doing business with is worth it. Although there were several attempts to standardize the way scores are presented, there is still variation that exists. This is because these scores need to be presented in several ways, depending on the type of usage. It is dependent on who will use it and how it will be used.

How a person is scored is heavily based on the way he pays his debts. This is also based on comparison. For example, if a debtor pays his debt 60 days late or just one month late, his paying behavior will then be categorized under the same group of people who have the same behavior. Then, statistical analysis and tools will show the probability of the risk of lending money to this person. Some of these statistical tools are proprietary in nature. This means it was the bank or the credit reporting agency that developed the mathematical formula, so the way they score is different from the others.

There are simply so many scoring models that one normal individual cannot comprehend how it was possible for him to be declined regarding his credit card application. Much to the dismay of many, they get disapproved for a loan they have been looking forward to just to pay off mortgages. In reality, very few consumers understand the true nature of credit risk scorecards and as such, one cannot do anything but to improve his credit rating.
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