Credit Scoring Its Effects And Diffusion Finance Essay

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Introduction

Credit scoring is a statistically derived numeric expression of a persons creditworthiness that is used by lenders to access the likelihood that a person will repay his or her debts. A credit score is based on, among other things, a persons past credit history. Credit scoring, using standardized formula is a measurement of credit risk. Factors that can reduce a credit score includes  absence of credit references, and late payments, and unfavourable credit card use. By using a credit score, lenders determine whether to grant a loan, what rate to charge and also the term.  For example, borrowers with a credit score that is under 600 will be unable to receive a prime mortgage and will typically need to go to a subprime lender for a subprime mortgage, in which will typically have a higher interest rate..

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The designation for credit scoring is the FICO score is the single best summary score of one’s credit worthiness. .A credit score number is often called a FICO score, a California company that developed the system upon which it is based. The score is supposed to distils all the information in your credit report, using a formula to calculate a single number that indicates your credit worthiness. It’s designed to give lenders a fast, accurate prediction of the risk involved in giving you a loan. Lenders have attested to the score’s value in streamlining the underwriting process and creating more opportunities for consumers to get mortgages. Scores range from the 300s to about 900, with the vast majority of folks falling in the 600s and 700s. The higher the score, the better.

Literature Review

Credit scoring: its effects and diffusion in the early stage

A study was conducted by Jalal Akhavein, Scott Frame, and Lawrence (2005) to illustrate the effects of the introduction of credit scoring on small business credit market and determine the factors that influence the adaptation of this financial innovative among large banking organization during the middle 1990s.

Jalal Akhavein, Scott Frame, and Lawrence (2005) stated that there were effects on borrower-lender interactions, loan pricing and credit availability since the introduction of credit scoring.They claimed that borrower-lender interactions might contract since credit scoring allowed lenders to grant or reject loans without physically meeting the borrower. They further stated the credit scoring might influence the price of credit as lenders would offer different price to borrowers according to the score gained. Regarding the availability of credit, they concluded there might be a rise in the number of credit, because cheaper or better information about the repayment prospects allowed lenders to price the credit accordingly, rather than rejecting loan out of fear.

Jalal Akhavein, Scott Frame and Lawrence (2005) discussed how the three variables –

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