What is a credit scoring and how does it affect me?
Credit scoring is the quickest, most accurate and consistent way of determining the likelihood that credit users will pay their bills. It uses mathematical models to evaluate a person's credit worthiness based on their credit history and current credit accounts. Credit scoring was first invented and developed in the 1950s, but has come into widespread use in just the last two decades. Consumers have benefited from scoring's speed and accuracy, which have helped them gain access to a wide variety of credit products. In the mid-1980's the three major credit bureaus, Equifax, Trans Union and Experian (formerly TRW) all worked with the Fair Isaac Company (FICO) to develop credit scoring models. These models allow each bureau to offer a score based solely on the contents of the credit bureau's data about a person. The actual numerical score is a number that indicates the likelihood that an individual will pay back a loan. It is typically calculated by reviewing the following parameters: Past payment delinquencies Current level of indebtedness Types of credit accounts currently open Length of credit history Number of credit inquiries How often credit is applied for Other derogatory credit behaviors Each major credit bureau has its own unique method for calculating credit scores. However, the scoring models have been somewhat normalized so that a numerical score at one bureau is roughly the equivalent of the same score at another. Therefore, a score of 600 from Equifax indicates the same creditworthiness as a score of 600 from Trans Union or Experian, even though the calculations used to determine those scores may be different at each bureau. Mortgage brokers and lenders frequently use these scores (commonly known as FICO scores) as an important factor in the decision whether or not to offer credit. The higher your credit score the better credit risk you are. Depending on the credit bureau, scores range from 375 to 900 points, but those numbers mean little on their own. They only become meaningful within the context of a particular lender's underwriting guidelines.
Frequently Asked Questions:
Q: What are credit bureau scores?
A: Credit bureau scores are just one type of credit score. It is computed and calculated from the information on your credit bureau file at the time it was requested. A credit score is like a snapshot: It sums up, at any given point in time, what your credit history and current usage predicts about your future credit performance.
Q: Where do scores come from?
A: Statistical scoring models calculate credit scores. Mathematical tables assign points for different pieces of information that best predict future credit performance. Developing these models involves studying how millions of people have used credit. Score model developers find predictive factors in the data that have proven to indicate future credit performance. Credit score models can be developed from different sources of data. A custom model can developed from a business's own data on its customers. Information is taken from credit application forms and credit bureau reports. Credit bureau models are developed from information in consumer credit bureau reports.
Q: What's in a scoring model?
A: A scoring model contains a list of questions and answers. A specific number of points are assigned to each answer. Only information proven to be predictive of future credit performance is used in a model. Below are some examples of what a typical model will (and will not) consider. Information from your credit application: How long you've lived at your current address Your current occupation Your financial obligations Information from your credit bureau report: Amount of outstanding credit balances Amount of credit you are currently using Length of time with established credit Any late payments made These items are definitely not considered: Your race Your gender Your religion Marital status Place of birth Neighborhood you live in
Q: How are scoring models used?
A: Credit scores give lenders a fast, consistent and reliable indication of how likely you'll be able to repay a loan according to the terms of your agreement. Scores are usually just one of many factors a lender considers in making a decision. This is particularly true in industries like mortgage lending where appraisals and other information play an important part.
Q: What is considered a good score?
A: This is a difficult question to answer. With most scoring models, the higher the score the better. Higher scores mean lower risk. For other scoring models it's the other way around. More importantly, every company using scoring decides for itself which scores are "good" and which are "not so good", based on its goals and estimates for certain types of loans. The score is only a tool, not a recommendation; the lender always makes the final determination. That decision may be to offer people with lower scores a different product, rather than turning them down.
Q: What if the credit bureau report has errors?
A: You should correct any errors on your report. It's a good idea to review your credit report from each bureau regularly. If you see an inaccuracy, report it to the credit bureau. The three major credit bureaus in the United States are Equifax, Trans Union and Experian. All of these companies have procedures for correcting information promptly. If you discover incorrect information when applying for a loan, be sure to tell your broker or lender. They should be aware of the fact that erroneous data may lead to an unusable score, and consider that fact when making their decision.
Q: Who calculates credit bureau scores?
A: Credit bureau scores are calculated by the credit bureaus and are based solely on the data in their credit reports at the time a lender requests the score. Lenders usually calculate application scores directly. Custom scores can be calculated by lenders or by the credit bureaus with which they work.
Q: How can I raise my score?
A: You can improve your future score, but it is unlikely that any single action you will take will have a large impact on your score immediately. This is because your score reflects your credit patterns over time. Here are some things you can do now that will improve your score in the future: Pay your bills on time. Delinquent payments and collections can have a major negative impact on your score. As they get older and you pay all other obligations on time, the delinquent information will have less impact. High outstanding debt can affect your score, so pay down any loan balances. Apply for new credit sparingly. Shopping for credit can have an adverse affect on your score. It is important to realize that there is no single action that will immediately raise your score. Each time a credit score is calculated, specific reasons (score factors) are delivered to the lender along with the score. If you've been given your score, you can ask your lender for these reasons. These factors represent the three major reasons why your score was not higher. Anything that you can do to address these factors will most likely improve your score.
Q: How do I find out what my score is?
A: Many lenders may tell you your score, though others may not. One reason is that many different types of scores are in use, therefore the number by itself might not hold much meaning to you. Another is that the scores can change on a daily basis as new information is added to your credit file. A credit bureau score is just a tool that lenders use. By itself it does not tell you if your application for credit will be approved or not. If you find out your score is 610, for example, you also need to know your lender's policy for those borrowers with scores in that range. Lenders are not required to disclose your score, but if you have been turned down for a loan in whole or part because your score was too low, they are required to give you the reasons for the score that you received. These reasons give you valuable information you can use to improve your score.
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