What Is A Credit Score?

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What Is a Credit Score?

Credit scoring is a scientific method that uses statistical models to assess an individual's credit worthiness based on their credit history and current credit accounts. Credit scoring was first developed in the 1950s, but has come into increasing use in just the last two decades.

In the early 1980s the three major credit bureaus, Equifax, Experian and Trans Union all worked with the Fair, Isaac company 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.

Each credit bureau has its own unique system. However, the scoring models have been normalized so that 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 Trans Union or Experian, even though the calculations used to determine those scores are different at each bureau.

Creditors--especially in the mortgage industry--frequently use these scores, known as FICO scores, as an important factor in the decision whether or not to offer credit. The 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.

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.

How Does Credit Scoring Benefit Me?

The widespread use of credit scoring such as the Credit Bureau Scores developed using the FICO model allows for speedy, objective analysis of credit histories. This means that borrowers who score well can get loan approval or credit almost instantly--something unheard of in years past. It also means that borrowers who once might have experienced problems with individual lenders' prejudices are less likely to do so. Because it is objective and based on large volumes of verified statistical data, credit scoring brings a new level of fairness to the credit-granting process.

What Factors Influence a FICO Score?

A FICO or Credit Bureau score is based on information drawn from your credit report. About 30 individual factors are used to determine the score. These can be categorized in five areas (in order of importance):

Payment history. Does the record show frequent late payments, public records such as judgments or bankruptcy, or derogatory notes like charge-offs or accounts turned over to collections?
Outstanding debt. How many outstanding balances appear on the credit report? What is the average balance? What is the ratio of total balances to total credit limits on revolving debt (e.g., credit cards, a home equity line).
Credit history. How long have you had your oldest account?
Pursuit of new credit. How many inquiries and new accounts does your report show, and how recent are they? How long has it been since the most recent inquiry?
Types of credit in use. How many accounts are reported for bank cards, travel and entertainment cards, department store cards, installment loans, and so on.

Also informative is the list of "reasons" that may be provided to account for why a score isn't higher. With each credit score generated, the credit bureau also creates a list of the four most significant reasons--either for a poor score or, in the case of a good score, for why it isn't "perfect."

The possible FICO reasons are:

Amount owed on accounts is too high.
Delinquency on accounts.
Too few bank revolving accounts.
Too many bank or national revolving accounts.
Too many accounts with balances.
Consumer finance accounts.
Account payment history too new to rate.
Too many recent inquiries in the last 12 months.
Too many accounts opened in the last 12 months.
Proportion of balances to credit limits is too high on revolving accounts.
Amount owed on revolving accounts is too high.
Length of revolving credit history is too short.
Time since delinquency is too recent or unknown.
Length of credit history is too short.
Lack of recent bank revolving information.
Lack of recent revolving account information.
No recent non-mortgage balance information.
Number of accounts with delinquency.
Too few accounts currently paid as agreed.
Time since derogatory public record or collection.
Amount past due on accounts.
Serious delinquency, derogatory public record, or collection.
Too many bank or national revolving accounts with balances.
No recent revolving balances.
Proportion of loan balances to loan amounts is too high.
Lack of recent installment loan information.
Date of last inquiry too recent.
Time since most recent account opening too short.
Number of revolving accounts.
Number of bank revolving or other revolving accounts.
Number of established accounts.
No recent bankcard balances.
Too few accounts with recent payment information.

The exact weighting of variables and calculations that go into creating a credit score are proprietary information that Fair, Isaac does not release, but it is generally true that a solid history of on-time payments to creditors will most likely result in a good score. Some of the factors considered do surprise people, though, and many consumers are interested in how to improve their score.

How Can I Improve My FICO Score?

The first thing to remember is that your FICO score can vary from month to month--even day to day, sometimes. This is because it is calculated based on the credit data available for you at the credit bureau on the day the score is requested by a lender.

However, there are things you can do to develop a solid credit history and influence your score for the better.

Pay your bills consistently and on time. And take heart--the scoring models all take into account the fact that everyone misses a payment once in a while. Also, negative information loses its potency over time: a recent late payment is weighted more heavily than a late payment four years ago.
Check your credit report and remove any errors. By making sure that only your accurate credit history appears on your report, you ensure that the FICO score it generates isn't lowered by inaccurate information.
Keep your debt reasonable. One rule of thumb: for a good credit score, your account balances should be below 75% of your available credit. For example, if you have a $2000 credit limit, you should have a balance of no more than $1500.
Maintain only a reasonable amount of unused credit. While it's good to have a cushion of credit available, having ready access to thousands of dollars of debt makes you a poorer credit risk.
Avoid too many inquiries. Inquiries are interpreted as a sign that you have been actively seeking credit, and may be in financial difficulties or in the process of overextending yourself.

How Can I Find Out My FICO Score?

It's difficult. Currently there is no law requiring that credit scores be released to consumers, and credit bureaus do not include the scores on copies of credit reports provided to consumers.

Because the scores are used differently by different lenders, and created differently by different credit bureaus, Fair, Isaac and the credit bureaus maintain that knowing a score is of little use to the consumer, and may simply be confusing.

Lenders are not required to reveal to potential borrowers what their FICO score (or any other credit score) is, but some will if you ask. As consumer awareness of credit scoring, and FICO scores in particular, grows, more and more lenders are willing to discuss it.

The lender should, however, tell you the reasons provided for a low score if that score is a factor in delaying or denying your loan application.