How to Design a Credit Scoring System

When customers apply for credit through your business, it's up to you as a business owner to decide how you rate them as borrowers. You can even design your own credit scoring system, making it as similar or dissimilar to the FICO credit scoring system as you wish. The key requirement is that your system assesses the likelihood that the applicant will repay the loan. You might consider the amount or type of debt the applicant owes, his tendency to make payments on debts, his income or a combination of these.

Instructions

1

Choose the criteria on which to assess credit applicants. The major credit reporting agencies (Equifax, TransUnion and Experian) use, in order of importance, payment history, amount of debt relative to credit, length of credit history, amount of new credit and types of credit. You could consider other criteria, such as an applicant's debt-to-income ratio.

2

Develop a number scale ranging from "high-risk borrower" to "low-risk borrower." Credit reporting agencies usually give consumers a number between 300 and 850, but your scale could range from 1 to 5, or from 0 to 100, for example. Set a point on the scale which applicants must rank for your business to approve them for credit; for example, 75 on a 100-point scale.

3

Assign a weight to each criteria from Step 1. For example, if you chose to assess payment history and debt-to-income ratio, you might consider the former more important than the latter and make an applicant's payment history count for 60 percent of his credit score and his debt-to-income ratio count for 40 percent.

4

Develop a point system for each criteria, so that you add or subtract points from a customer's score based on his credit history. For example, you might subtract one point for every late payment a customer makes to a creditor and two points for every payment he never makes; you might give him one point for every two percentage points his credit exceeds his debt in his debt-to-income ratio. Do not let the total for any criteria exceed the percentage you set for it in Step 3. Using the example from Step 3 and a scale ranging from 0 to 60, an applicant's payment history points can't exceed 60 and his debt-to-income ratio points can't exceed 40.

5

Make an inquiry for a customer's credit report when she applies for credit through your business. Apply your scoring system to the items in her history and approve or deny her on this basis. Explain your business's scoring system to prevent confusion.