Credit Basics
What
Is Credit Scoring?
You've heard of credit scoring, but what exactly is it?
Credit scoring is a scientific method that uses statistical models to
assess an individual's credit worthiness based on his or her credit
history and current credit accounts. Credit scoring was first developed
in the 1950s, but has come into increasing use in the last two decades.
In the early 1980s the three major credit bureaus,
Experian, Equifax and TransUnion all worked
with the Fair Isaac Corp. to develop generic scoring models that allow
each bureau to offer a score based solely on the contents of the credit
bureau's data about an individual. Creditors especially those in the
mortgage industry frequently use the scores when deciding who receives
loans. They can order your score, commonly called a FICO score, from one
of the bureaus, but it only draws upon information from your credit report.
Individual creditors often also consider other information, such as your
salary or how long you have been employed at the same company when making
loan decisions.
Now you can see the type of score lenders use when deciding
whether to give you that loan. Along with your Personal Credit Score,
you’ll receive personalized analysis and tips that can help you improve
your credit rating. So know the score today!
What
does it mean?
Each credit bureau has its own unique system for compiling
credit scores. However, the scoring models have been normalized so a
numerical score at one bureau is the equivalent of the same numerical
score at another. Thus, a score of 700 from Equifax indicates the same
creditworthiness as a score of 700 from TransUnion
or Experian, even though the calculations used to determine those scores
are different at each bureau.
A computer-generated score is compiled using information
from an individual's credit report, such as how much money is owed and
whether payments have been made on time. Then that score is compared to
the credit performance of consumers with similar profiles. The scoring
system awards points for each factor that helps predict who is most
likely to repay a debt. A total number of points-a credit score--helps
predict how likely it is that you will repay a loan and make payments on
time.
Credit scores range from 375 to 900
points, but those numbers mean little on their own. They become
meaningful and useful within the context of a particular lender's own
cutoff points and underwriting guidelines.
What’s
a good score?
In general, you are likely to be considered a better credit
risk if your FICO score is high. Under mortgage lending guidelines, for
example, a score of 650 or above indicates a very good credit history.
People with these scores will usually find obtaining credit quick and
easy, and will have a good chance to get it on favorable terms.
Scores between 620 and 650 (average FICO scores fall into
this range) indicate basically good credit, but also suggest to lenders
that they should look at the potential borrower to assess any particular
credit risks before extending a large loan or high credit limit. People
with scores in this range have a good chance at obtaining credit at a
good rate, but may have to provide additional documentation and
explanations to the lender before a large loan is approved. This means
that their loan closing may take longer, making their experience more
like that of borrowers in the days before credit scoring, when every
individual was researched.
A score below 620 may prevent a borrower from getting the
best interest rates, as they may be considered a greater credit risk-but
it does not mean that they can't get credit. The process will probably be
lengthier and, as noted, the terms may be less appealing, but often
credit can still be obtained.
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