What Is a Credit Score?

    Credit Scores

    If someone asks for your credit score, the proper response should be a quizzical wince.


    Yes, a quizzical (puzzled or questioning) wince (painful flinch), because figuring out which of the many numbers offered is actually your credit score can be a painful and puzzling process.

    A credit score is a 3-digit number that is supposed to reflect the likelihood that a consumer will repay his debts. The problem is there are many scoring models used to determine your credit score. The variety of models means your score can vary several points, depending on whose model is used and what type of company (Department store? Car dealership? Bank?) is asking for it.

    For example, the most recognized credit score is the “FICO score,” which comes from the Fair Isaac Company. FICO has 49 different versions of your score that it sends to lenders. The score may change by a few or many points, depending on what company asks and what was important to that company in calculating your score.

    Thus, your FICO score for a department store might be slightly better (or worse) than your FICO score for an auto loan. And that will be slightly different from your FICO score for insurance, which could vary from your score for a mortgage loan.

    It’s also possible the inquiring company could use your Vantage Score, a CE score or one from any of three of the major credit reporting bureaus, Experian, Equifax and TransUnion, to judge your credit worthiness.

    And if you happen to be in a debt consolidation plan, that too will impact your score.

    Confused? Hang in there. We can wipe away that quizzical wince.

    What Is a Credit Scoring Model?

    Credit scoring models are statistical analysis used by credit bureaus to evaluate your worthiness to receive credit. The agencies select certain statistical characteristics found in a person’s credit payment patterns, analyze them and come up with a credit score.

    Scoring calculations are based on payment record, frequency of payments, amount of debts, credit charge-offs and amount of credit cards held. A certain weight is assigned to each factor considered in the model’s formula, and a credit score is assigned based on the evaluation. Scores generally range from 300 on the bottom end to 850 on the top end.

    Lenders use credit scores to help determine the risk involved in making a loan, the terms of the loan and the interest rate. The higher your score, the better the terms of a loan will be for you.

    FICO Scoring Model

    The FICO scoring model is considered the most reliable because it has the best track record. It’s been around since 1989 and there have been numerous revisions over the last 27 years to take into account the changing factors that would be relevant to arriving at an accurate credit score.

    The “classic” FICO scoring model gives consumers a number between 300 and 850. A score under 600 is considered poor. A score above 740 is considered excellent. In between is average to above average.

    The latest scoring model is FICO 9 and it debuted in 2014. The major difference in the FICO 9 model is that it put less weight on unpaid medical bills.

    It succeeded FICO 8, which came out in 2009 and is the version most heavily used by the lending industry. FICO 8 penalized consumers for spending close to their credit limit every month and offered leniency to those who made an “isolated” late payment, meaning one that arrived more than 30 days late.

    When FICO releases a new version of its scoring model, lenders have a choice: Upgrade or stay with the version they have. Many lenders opt to stay with the version they have because it can be expensive to upgrade.

    FICO compares it to a consumer upgrading a computer operating system every time a new version of Windows is released. You may be satisfied with Windows XP or you may have upgraded to Windows 8, or 10.

    The same happens with businesses and lenders who use the FICO score. Some lenders are still using FICO 5, some have upgraded to FICO 9. The only way to know is to ask.

    How Are FICO Scores Calculated

    Regardless of which FICO model is used, there are five factors that most influence a “classic” FICO score: Payment history; credit utilization; credit history; types of credit; and new credit. There are many sub-categories calculated within each area before arriving at a final score:

    Payment History

    Payment history counts for 35% of your score. If you make payments on time every month and don’t have negative public records for lawsuits, liens, bankruptcies or foreclosure, you will do well in this category. Late payments are a negative. The later the payment — a month versus a week – the more your score gets dinged.

    Credit Utilization

    Credit utilization counts for the next 30% of your FICO score. Don’t spend close to your credit limit, even if you intend to pay off the bill every month. FICO likes you to use 30% or less of the available credit. If you have a $1000 limit on your credit card, that means limiting spending to under $300 a month.

    Credit History

    Credit history is the third factor, counting for 15%. The longer you own a credit card, the more it improves your score, provided you pay it off every month.

    Credit Use

    Credit use is worth 10%. FICO wants to know how many forms of credit you have (credit cards, auto, mortgage, utilities, etc.) and how well you keep up with them.

    New Credit

    The last category, new credit, is the final 10% of the equation. It’s OK to apply for a credit card, but if you apply for several at the same time, it may be an indication you’re using one to pay off others and that is a negative. The same logic applies to asking for a car loan at the same time you ask for a home loan. It’s better to spread those applications out over time.

    VantageScore Model

    The VantageScore model was introduced in 2006 when the three major credit reporting bureaus Experian, Equifax and TransUnion, decided to offer FICO some competition in the credit score business.

    The VantageScore model looks at familiar data, things like paying on time, keeping credit card balances low, avoiding new credit obligations, bank accounts and other assets to calculate its score.

    The difference for the latest model, VantageScore 3.0, is that it needs only one month of credit history to establish a score, as opposed to the six months needed for FICO and other models.

    Other factors unique to VantageScore include ignoring collections —paid or unpaid — under $250 and relief for accounts negatively affected by natural disasters. The VantageScore scoring scale that is the same as FICO’s 300–850, but it includes a letter grade (A through F) to help you better understand your score.

    The VantageScore uses information from all three credit reporting bureaus, but weighs certain factors more heavily or less heavily than the FICO algorithm. Thus, the scores should be similar, but rarely identical.

    Industry-Specific Credit Scores

    Remember when we were discussing how many credit scores there are for every consumer? Much of that comes from FICO’s decision to drill down deeper into financial data and help lenders predict how you will do with specific types of loans, such as a mortgage or auto loan or credit cards.

    On top of that, the three major credit bureaus that provide data to FICO, all want industry-specific scores as well. Thus, Experian and Equifax provide 16 different FICO credit scores to lenders and TransUnion has 21.

    And there are more being added every year!

    Industry specific scores are optimized for certain types of credit products like an auto loan or credit card. FICO uses the same base of information available in its “classic” scores, but fine-tunes the data based on industry-specific risk behavior.

    So, if you are buying a car, the dealership or bank offering you a loan may want to know your credit history for paying off similar loans on a monthly basis. They may want to factor in past car loans, credit card payments or rent and utility payments to judge the risk they’re taking by giving you an auto loan.

    The scoring model for industry-specific scores and “classic scores” is the major difference between the two. The range for industry-specific scores is 250-900, while classic scores fall between 300 and 850.

    Scoring Models Keep Secrets

    Companies that develop scoring models prefer to keep details of the models behind closed doors because they consider them privately held and because they make money by selling results of the models. However, given the information that banks and credit card companies ask on their applications, it is not difficult to interpret some factors that weight heavily on your score.

    Among the factors considered are:
    • Bankruptcies, collections, missed payments and foreclosures listed on your credit report
    • Your occupation and your time at your current job
    • Whether you own or rent your residence
    • Amount of time at your current location
    • The number of inquiries into your credit over a period of time
    • The balances of your used credit to your available credit
    • Your age
    • The length of your credit report
    • The length of time your credit history has been in the bureau’s database

    Credit scoring model practice changes

    Credit scoring models were first utilized in the credit industry more than 50 years ago. They were developed as a way to determine a repeatable, workable methodology in administering and underwriting credit debt, residential mortgages, credit cards and indirect and direct installment consumer loans.

    Early models were based on a greater degree of subjectivity rather than statistical analysis, and those resulted in discriminatory and fraudulent loan and credit practices. Over time, a number of state and federal protections were put into place to reduce the subjectivity and make the process fair, equitable and transparent.

    Two of the protections are the federal Fair Credit Reporting Act and the Equal Credit Opportunity Act, which outlaw the consideration of marital status, race, religion or sex as factors in making credit-scoring decisions.

    Benefits of credit scoring models

    The major benefit to consumers of having credit scoring models is speed. Lenders can evaluate thousands of applications quickly and impartially. A decision on a mortgage, a car loan or an extended limit on credit cards that would take weeks or even months, can be handled in days or even minutes.

    In fact, the consistency of data in scoring models allows for financial statements, credit ratings, credit account statuses to be evaluated quickly and accurately. It also reduces the possibility for human error in the evaluation process. This helps customers and their orders get processed more quickly.

    On the flip side, it reduces bad debt losses for companies, who might otherwise make bad decisions in whether to extend credit to a customer. Businesses can specify the factors they want considered in the credit decision process and know almost immediately if they are dealing with a high-risk or low-risk customer.

    That has allowed the businesses to operate more efficiently and reduce the cost of vital services like mortgages, car loans and credit cards.

    Credit scores allow consumers access to lending resources and help financial institutions control allocation of risk and costs with their customers. Businesses can better execute transactions with customers when the business has access to objective information to evaluate a customer’s creditworthiness.

    Consumers also benefit when they are rewarded for on-time, responsible payment of debts that improve their credit score. This gives them access to the credit they need to take advantage of products in the market. The scores also serve as an incentive for good financial decision making.

    2 Types of Credit Scoring Models

    While there are a number of credit scoring models utilized to determine a person’s credit worthiness, there are essentially two distinct types of scoring models that can be validated statistically.

    These models will either use a statistical or judgmental scoring analysis. In each case, the end credit score result can vary as well.

    A statistical scoring model utilizes multiple factors from one or a number of credit reporting agencies, correlates them and then assigns weights to each factor. The model does not consider the individual judgments or experiences of any credit officials.

    A judgmental scoring model considers a person or organization’s financial statement, payment history, bank references and even the credit official’s own previous experience in handling its products and services. By including these elements in someone’s credit history, a subjective judgment is given more weight in determining the credit score.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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