Have you ever wondered what your life would be like without the ‘all powerful’ credit score? It might surprise you that credit scores, credit bureaus and credit repair did not exist before the 1950’s.
Bear with me as we go back in time to where the trouble began:
Lending in the Middle Ages
Importance of your name
Back in the Middle Ages, getting approved for a loan was heavily dependant on who you were related to– sometimes even more so than what you did for a living. That’s where the importance of the last name came into play. For many people it would be common for their surname to be based on their profession, town or estate such as “Smith” or “Baker”. Other people would use their father’s name to provide credibility, as in “Johnson or “Peterson”.
Lending back then was a highly volatile and risky business, and even English Monarch defaulted on loans. For those not lucky enough to be born into royalty, defaulting on a loan in the Middle Ages was a pretty gruesome business. Although it usually wasn’t a matter of life and death, like in Shakespeare’s Merchant of Venice, it sometimes lead to lifelong debt. This was the dark side of debt collection.
The Dark Side to Debt Collection
Although creditors often justified their practices with the amount of financial risk they were taking, they were often unfair and inconsistent on how they collected their debts. One historically unfair debt collection practice was debtors’ prison. If you have ever picked up a book by Charles Dickens or any other Victorian Era novelist, you have probably heard of it. Essentially this was a place that creditors could lock up anyone that owed them money until it was repaid. Unfortunately due to the limited earning potential of an incarcerated debtor, most people would remain in prison for the rest of their lives. This practice was eventually banned by federal law in 1833.
Consumer protection increased with the abolishment of some unfair collection practices, however there was still a need to prevent people from overextending themselves in the first place. But the creation of a standardized credit score was still years in the making.
The First Credit History Reports
Before credit scores there were credit histories, and the first ones were very basic. The data collected was just enough to determine if someone had bad spending habits. Back before credit cards or fancy in-store financing, local store owners would use pencil and paper to keep tabs for customers and trust their customers to pay off their debt. As the stories go, one day a couple store owners in a small town sat down together and compared notes, they soon noticed that Bob didn’t pay any of his bills and they all agreed to take cash only from him. It was then that bad credit was born, and the first credit history report was written. But credit reporting didn’t stop there and companies began to expand what and how much information they collected. By the late 1960’s TransUnion had over 4 million files written on index cards.
I’m a good person, so why can’t they just trust me?
Up until the 1950’s everything was mainly character-based lending. Essentially you would sit down with some banker or lender and talk to them like you would at a job interview, make your best impression, and hope for the best. But first impressions can be misleading, not to mention very subjective. You could do be on your best behavior and have all the right answers but if the banker didn’t like you, or if you reminded them of someone they didn’t trust, then you were just stuck out of luck. Not to mention that this process was opening the door to discrimination on race, gender, religion, and many other things.
The Not-So-Private ‘Welcome Wagon’:
Speaking of opening the door to discrimination…
The face-to-face interview just wasn’t cutting it, so in 1899 a company called Retailer’s Credit Company (later to be renamed Equifax) decided to take it one step further and do a home visit. A potential loan recipient would open their door to what they called a ‘Welcome Wagon,’ which was basically a banker with a clipboard. He or she would come to your house, meticulously note everything you owned and what condition it was in, the overall quality of your life, what you did and who you did it with, and any other extra exciting tidbits that you might not want to be made public. If you thought an unexpected visit from the in-laws or other relatives was unnerving enough, imagine opening your door to a stranger whose opinion could affect your entire future financial life. No pressure there!
But, believe it or not, that wasn’t the worst part. Credit information collectors used to sell these details to anyone and everyone willing to pay the right fee– except for the consumer. This eventually prompted congress to create laws to protect consumers and their information starting with the Fair Credit Reporting Act of 1970.
The Beginning of Credit Scores:
It seems only fair that someone named Fair would help create the foundation of an unbiased lending system.
Without a standardized scoring and tracking system, there was little way to predict who could be trusted and who couldn’t, so banks and lenders kept making poor decisions. But in the 50’s the founders of the Fair Isaac Corporation (FICO), Bill Fair and Earl Isaac, decided to do something about the inconsistent and biased way of lending.
The credit score was born.
While it wasn’t popular at first, after a few tweaks to the equation, the FICO score soon replaced the early handshake and welcome wagon committee as reliable indicators of creditworthiness.
The FICO score is a number generated by a special algorithm, or equation, that statistically predicts someone’s credit risk. Contrary to what some people might think, this score isn’t based only on how much money you have or how much money you earn. It’s also based on how you spend and handle your finances. Charles Dickens puts it wisely in his book, David Copperfield:
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds … and six, result misery.”
After the credit score was initially invented it would take decades of system reform before the credit reporting bureaus would become regulated and resemble the modern shape they are in today (i.e. Such as the Fair Credit Reporting Act and the rise of Credit Repair). Now the Credit Score is the most powerful number in a consumer’s life.
Check out this article on how to raise your score up to 100 points.