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Finance Dictionary and Glossary of Investment Terms

credit scoring  

Definition 1.

A statistical technique used to determine whether to extend credit (and if so, how much) to a borrower. Credit scoring is often considered more accurate than a qualitative assessment of a person's credit worthiness, since it is based on actual data. When performing credit scoring, a creditor will analyze a relevant sample of people (either selected from current debtors, or a similar set of people) to see what factors have the most effect on credit worthiness. Once these factors and their relative importances are established, a model is developed to calculate a credit score (a number indicating how credit-worthy the applicant is) for new applicants. The officer inputs applicant-specific information for each variable in the model, and can thus find out how credit-worthy he/she is. Developing a credit scoring model is usually a time-consuming, complicated process given that creditors often have to look at a large sample and consider many different variables. Thus, these models are usually developed at the firm level as opposed to the individual credit office level. Some of the factors considered when developing a credit scoring model are outstanding debt, the number of credit accounts maintained, age, income, credit history, etc. As required by the Equal Credit Opportunity Act, a credit scoring model cannot consider race, sex, marital status, national origin, or religion. If age is considered, the analysis should be such that older people are given equal consideration in a credit application.
 
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