A credit score is the numerical expression of an individual’s creditworthiness and indicates in numerical, quantifiable terms the statistically calculated likelihood that the person in question will prove a reliable lender – or not. Credit scores are based on specific information from an individual’s financial behavior and include data regarding a person’s payment history, credit use (calculated as the ratio between the amount of revolving debt and the credit limit available to that individual), length of credit history, types of credit employed both currently and in the past and finally the amount and types of credit procured recently. All this data is computed (according to secret yet statistically monitored models and formula) and turned into a number – known as credit score – that is subsequently made available to lenders such as banks and credit card services providers.
The number that expresses a person’s credit score is then assessed in several ways. Its value as such is important, as it determines to which credit score bracket an individual is assigned. The majority of credit scores are mathematically scaled so that they fall in the general range employed by scoring model competitors. With credit scores, the general principle is that the higher your score is, the better you will fare in the eyes of the lender; this in turn will impact your financial credibility. A credit score is basically an individual’s business card in the world of credit: a good credit score opens the door to lower interest rates and higher credit limits, while a lower score may effectively block a person’s access to credit or prompt a lender to charge higher interest rates, ask for additional more collateral or request extensive income and asset verification prior to approving loan or mortgage applications. Banks and other lenders employ credit scores as tools to assess the amount of risk to which they expose themselves when lending money to particular consumers, and regard credit scores as extremely predictive or risk – or its absence thereof.
Credit scores are extremely complex, both with regard to the manner in which they are calculated and to the uses to which they are put. There are three credit reporting agencies in the US, each of which may have different information regarding an individual’s credit history, and in addition to the widely popular FICO score there are many other credit scoring models. It is thus possible – in fact, it is customary – for an individual to have at least three different, separate credit scores. Also, banks routinely devise their own internal credit scoring models, in which they may include, in addition to the credit history elements mentioned above, other aspects such as employment history, current income and even tenancy status.
Once an individual’s credit score is revealed, it can be used as a stand-alone indicator or else compared to the credit scores of other consumers whose current revenue information (for example) or else credit history (including any past late payments) is similar to yours. Once all these mathematical variables have been computed, the would-be borrower is included in a particular category and any pending financial decisions are taken accordingly. It is well to remember that large financial services providers build their own databases and compile data from multiple sources in order to reach a decision which they regard as statistically sound and therefore, risk-free.
The credit score
The best known credit score model, which is also the most widely employed such statistical algorithm in the US was developed by FICO. The company sells its FICO scores to consumers directly via its myFICO.com online portal using data from Equifax and TransUnion, two of the three US credit reporting agencies. Equifax and TransUnion also allow consumers to directly purchase FICO scores from them. But how exactly is an individual’s FICO score obtained? We can only provide an approximate answer to this popular question, as the company’s exact formula for credit score calculation is a most jealously guarded secret. In response to consumer pressure, FICO has nevertheless revealed which elements are taken into account when calculating a score and how much each element weighs in the final result.
Thus, the most important element in a FICO credit score is a person’s payment history, which makes up 35 percent of the final figure. The score is dragged back by such negative elements as late mortgage or credit card payments. Also ranging among the top factors which influence an individual’s credit score is the so-called rate of credit usage, which represents 30 percent of the final score. This refers to the amount of incurred debt as compared to the amount of credit available to a consumer at a particular time. In more technical terms, this is expressed as the ratio of revolving debt to the total revolving credit. The lower an individual’s credit utilization (or indebtedness) ratio, the higher are his chances to have a high FICO score. Also taken into account are the duration of a person’s credit history (15 percent of their final score), as well as the types of credit employed and the amount of recently obtained credit, each making up 10 percent of the score. In addition to these elements, a FICO score can be negatively influenced by the amount of money an individual owes due to a tax lien or any type of court judgment and by the existence of consumer finance credit accounts.
But what is a good credit score? This one question frequently occurs among consumers looking to assess the state of their personal finances. They should be aware that FICO credit scores rank from 300 to 850. FICO representatives indicate that the average (or median) score is 723. Of course, all scores are frequently readjusted based on recent events and aligned within separate scoring models employed by the three US credit bureaus – Experian, Equifax and TransUnion. Given that the bureaus also administer separate databases, any modifications in individuals’ credit scores are also aligned across the three credit bureaus.
The credit score
The three previously mentioned credit reporting agencies – namely Experian, Equifax and TransUnion – centralize consumer information and employ FICO software to put together credit reports and produce separate FICO scores; they subsequently sell the scores to interested financial services companies or else (in Equifax and TransUnion’s cases) directly to consumers. Any individual therefore has at least three credit scores, each compiled by one of the three credit reporting agencies. The scores may vary from one agency to the next, due to differences which occur between the bureaus with regard to the scoring models they use, the creditors from which they obtain their information and the time at which particular details reach them.
In 2006, Experian, Equifax and TransUnion made a bid to take over some of FICO’s market share in the field of credit reporting, and launched VantageScore, a separate scoring model. Not only does VantageScore employ a different number range (rating consumer credit scores from 501 to 990 as compared to from 300 to 850 in FICO’s case), but it also assigns letter grades ranging from A to F to score ranges. Those asking themselves what is a good credit score for the VantageScore system should know that the top VantageScore is A and ranges between 901and 990, while B ranges from 801 to 900, C from 701 to 800, D from 601 to 700 and finally F from 501 to 600.
In November 2003, the United States Congress passed the Fair and Accurate Credit Transactions Act (FACT Act or simply FACTA), under which all legal US citizens are rightfully entitled to receive a copy of their credit report for free once every year. However, the free credit report does not explicitly state a consumer’s credit score, which still needs to be purchased and may be solicited (for a fee) at the time when the free credit report is provided. This means that essentially there is no such thing as a free credit score - only a free credit report. A consumer can also access his or her credit score by subscribing to a credit report monitoring service. There are a number of such offerings provided by the three main credit bureaus or else by third-party providers, however they come with a monthly membership (subscription) fee.
Although credit scores have been acknowledged to lower the risks and costs of providing credit to consumers, the system has not been without controversies or critics. One example of a situation which can negatively and unjustly impact consumers is that in which a lender does not update the information in a borrower’s report in a timely fashion by clearly stating that a debt has been paid off or else reduced. If this occurs, the debt in question will not be erased from the credit report unless the consumer himself intervenes, locates the error and reports the update. Also, there are some who claim that FICO scores in particular can be artificially boosted, although under the new FICO 08 version of the FICO score this possibility has reportedly been severely limited.
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