Understanding the Ins and Outs of Your Credit Score

by Admin
9 minutes
Understanding the Ins and Outs of Your Credit Score

As recent as a few years back, the term "Credit Score" was not very commonly used in our society. In comparison, some people understood the word and its purpose, the mass majority, although realizing that there was a system out there that their credit, did not have a term to stick.

Today, however, due to several factors such as increased Identity Theft and mass media marketing campaigns, very few are not aware of the term Credit Score. This article aims to add understanding of the person to recognize that term.

A Credit Score is between 300 and 850 based on a statistical analysis of an individual's credit activity. It is used to represent the creditworthiness of an individual. How likely that the individual will pay their debts. A credit score is based on credit report information typically sourced from credit bureaus and reference agencies, typically from the three major credit bureaus.

Lending institutions, such as banks, finance companies, mortgage lenders, and credit card companies use an individual's Credit Score to evaluate the potential risk posed by lending money to that individual. Lenders use Credit Scores to determine who qualifies for a loan, what interest rate the loan is issued, and what credit limits are determined.

The use of credit scoring before granting credit is a trusted system throughout the industry. Credit scoring is not limited to banks, however. Organizations, such as mobile phone companies and government departments, employ the same techniques.

While there are many others, such as NextGen, VantageScore, and the CE Score, The most widely known score in the United States is FICO, which is more commonly used in the mortgage industry. FICO is an acronym for Fair Isaac Corporation, which provides the most well-known and most widely used credit scoring system in the United States.

The FICO score is calculated by applying statistical methods developed by Fair Isaac to information in one's credit file and is primarily used in the consumer banking and credit industry. FICO scores show how likely it is that a borrower will default. A separate score, BNI, indicates the likelihood of bankruptcy. No public information is available to determine the mean scores in terms of statistics.

As stated, banks and other lending institutions use Credit Scores as factors in their lending decisions. Whether credit is denied or approved, what interest is charged, what income level and asset verification are required is all based on an individual's credit score.

The FICO score uses slightly different scoring methods to rate a consumer's suitability for three different types of credit; mortgages, auto loans, and consumer credit. Each reflects the additional credit risks of these various types of lending. It is not unusual for these scores to differ by 50 points or more for the same borrower.

There are three major credit reporting agencies in the United States. Although frequently inaccurately referred to as "credit bureaus," these agencies, Equifax, Experian, and TransUnion, also calculate their credit scores. These additional scores differ depending on what they are meant to predict, what statistical methods are used to determine a score, what information is used, and how weighted.

These additional Credit Scoring Systems are numerous and are agency-specific. For example, Beacon, Beacon 5.0, Beacon 96, and Pinnacle scores are available only from Equifax. Empirica, Empirica Auto 95, Precision Score, and Precision 03 are available only from TransUnion. And Fair Isaac Risk Score at Experian.

These various Credit Scores are developed for the different agencies by Fair Isaac; each differs and is periodically updated to reflect current consumer repayment behavior habits. The NextGen Score is a scoring model designed for consumers.

To make credit scoring more consistent across the board, in 2006, the big three credit reporting agencies introduced Vantage Score. Vantage Score uses a different number range from the FICO score. It ranges from 501 to 990 and assigns letter grades from A to F to specific scores fields.

A consumer's Vantage Score may differ from agency to agency. Still, the difference would be entirely due to differences in the information reported to the various agencies, not due to differences in scoring systems. Since FICO is still widely used by lenders, the agencies continue to offer FICO scores (or their closest equivalent).

Most credit scores use a multiple-scorecard design. Each version may use individual scorecards, and an individual potential borrower is typically compared with other previous borrowers. In other words, a borrower with one 30-day late payment will be scored against a population with some similar delinquency. A borrower with two 30-day late fees will be scored against people with like credit faults. The individual is then graded according to which variables indicate a risk within that group.

Nearly all large banks also build and use their systems for credit scoring purposes and are frequently conjunction with outside scoring formulas.

The systems used to generate credit scores are subject to federal regulations. The Federal Reserve Board's Regulation B, which implements the Equal Credit Opportunity Act, expressly prohibits a credit scoring system from considering any "prohibited basis" such as race, color, religion, national origin, sex, or marital status. It also stipulates that credit scoring systems must be "empirically derived" and "statistically sound."

The statement "credit score not high enough" is insufficient. The reasons for denial must be specific; "too many delinquencies 60 days or greater" and such. In addition, if an adverse action, a denial of a credit application, is taken due to the credit score, then the specific reasons for the rejection must be provided to the individual denied.

Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulas for calculating credit scores are closely guarded secrets, the Fair Isaac Corporation has disclosed the following components and the approximate weighted contribution of each:

35% punctuality of payment in the past (30 Days Past Due)
30% the amount of debt, expressed as the ratio of current revolving debt to total available revolving credit
15% length of credit history.
10% types of credit used
10% recent search for credit and/or amount of credit obtained recently

These percentages offer limited guidance in understanding a credit score. For example, the
10% of the score allocated to "types of credit used" is undefined, leaving consumers unaware of what type of credit mix to pursue. "Length of credit history" is also a murky concept; it consists of multiple factors, two being the oldest account open and the average length of time an account has been available.

Interestingly, although only
35% is attributed to punctuality, if a consumer is substantially late on numerous accounts, his score will fall far more than
35%. Bankruptcies, foreclosures, and judgments affect scores substantially but are not included in the very vague pie chart provided by Fair Isaac.

A FICO score generally has a max of 850 and a minimum of 300. It exhibits a left-skewed distribution with a median of around 723. The performance of the scores is monitored, and the scores are periodically aligned so that a lender does typically not need to be concerned about which scorecard was employed.

Because the three major credit agencies have their independent databases, each of us has three credit scores for any given scoring system. As these databases are separated, they may contain entirely different data. Many lenders will check an applicant's score from each bureau and use the median score to determine the applicant's creditworthiness.

As a result of the FACT Act (Fair and Accurate Credit Transactions Act), each legal U.S. resident is entitled to one free copy of their credit report from each credit reporting agency once every twelve months. To guard against inaccurate information or fraud more often than yearly, one can request a message from different credit reporting agencies available on the net. This information is available from several websites across the net that offer a free credit report and use of their services for 30 days. After which, there is a monthly fee involved. The price is nominal compared to the necessity of protecting your credit in today's highly technological society, where identity theft is becoming more prevalent.

Having a good Credit Score is becoming more and more prevalent in our society. When identity theft and credit fraud are on the rise, the fee these firms charge seems like a small amount to pay to protect your credit and your good name. Here are a few examples of how:

In September 2004, TXU (a Texas utility company) announced it would begin setting individualized electricity prices based on credit scores. However, the plan was not implemented due to negative press and pressure from the Texas Public Utility Commission.

Credit scores are often used in determining prices for auto and homeowner insurance. Recently, some of the agencies that generate credit scores have also been generating more specialized insurance scores, which insurance companies then use to rate the quality of potential customers. These scores are unavailable to consumers.

Many employers reserve the right to do a credit check on job applicants. Similarly, they reserve the right to drug test potential employees. It is recommended that you take the time to visit them and read through the numerous articles and reports there. The fact is that your Credit Score is critical. Rebuild-Credit.us is a sight committed to providing consumers with quality information concerning credit, how to get it, and how to maintain a quality credit score.