| Credit Score |
Article Index for Credit |
Website Links For Credit |
Information AboutCredit Score |
|
Lenders such as Bank s and Credit Card companies use credit scores to manage the risk posed by lending money to consumers. Examples of such uses include determining who qualifies for a loan, assigning an Interest rate, assigning credit limits, and managing accounts that are already open (for example, treatment of accounts that are in Default ). The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a Trusted System . While the most widely-known score in the United States is FICO, there are many others, such as NextGen and Vantage. THE FICO SCORE FICO (rhymes with psycho) is an acronym for Fair Isaac Corporation (traded publicly under the symbol FIC) and often refers to the best-known credit score in the United States which is calculated using mathematical formulae developed by this company. This score is one of the most important factors in obtaining credit in the United States. For institutions that use scores as a factor in their lending decisions, scores below certain numbers (typically set by each lender's Risk Management department) may result in denial of credit, or credit being offered at a higher interest rate. The three major credit reporting agencies in the United States, ( Equifax , Experian and Trans Union ) calculate their own FICO scores, which go by different trademark names as well as many different versions of the score (often differing because what they are meant to predict and when they were written): For example Beacon, '''Beacon 96''' and the '''Pinnacle''' are all available only from Equifax; '''Empirica''' '''Empirica Auto 95''' '''Precision Score''' and '''Precision 03''' at Trans Union, and '''Fair Isaac Risk Score''' at Experian. These versions, while all developed for the agencies by Fair Isaac, differ and are periodically updated to reflect current consumer repayment behavior. The NextGen Scores are the most recent scores, but creditors vary in which version they prefer to use. The scores use a multiple scorecard design. Each version uses 10 or more individual scorecards, and an individual is typically compared with similar others. (For example, a borrower with two 30-day late payments will be scored against a population with some minor delinquencies.) An individual is then graded according to what variables seem to indicate a repayment risk in that group. This feature may cause a borrower with delinquencies to score in the same range as a borrower without delinquencies. It is worth mentioning that each of these credit reporting agencies also have developed their own separate proprietary versions of a credit score intended to compete with Fair Isaac's score. Although not as widely used, these scores (for example Trans Union's "TransRisk" score or Experian's "ScoreX" score) are less expensive than the FICO score and, in some situations, may more accurately predict the risk level of a prospective borrower. The cost savings of a non-FICO score are tempting to some banks and credit card companies, who need an accurate risk assessment on millions of accounts every year. Only time will tell if these alternative scores will displace Fair Isaac from its dominant position in the U.S. market for credit scores. Nearly all large banks also build and use their own proprietary statistical models for credit scoring purposes, often in conjunction with the FICO score or other outside scores. The statistical models that 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 model from considering any prohibited basis such as race, color, religion, national origin, sex, or marital status. Regulation B also stipulates that credit scoring models must be empirically derived and statistically sound. Furthermore, if an adverse action is taken as a result of the credit score (e.g. an individual's application for credit is denied) then specific reasons for the denial must be provided to the individual. A statement that the individual "failed to score high enough" is insufficient; the reasons must be specific. There exist several generally accepted Algorithms for extracting the primary contributing factors to a low credit score. One or more of these algorithms is typically used to supply a list of reasons when a loan applicant has been denied credit, in order to satisfy the Regulation B requirement that specific reasons are disclosed. Some consumers feel these adverse action reasons are somewhat disingenuous, as the only determining factor for credit denials is a numeric score — the "reasons" are summed up only for the consumer. As mentioned above, each credit bureau also has one or more of its own generic credit scores, available both to consumers on their websites and to lenders. For ease of use, these scores tend to be mathematically scaled so that they fall in the same general range as the FICO score. These scores are used by some businesses to assess creditworthiness (otherwise they would not be offered), however the FICO score remains the dominant score in use today. Fair Isaac offers scoring models for the U.S., Canada, and South Africa. It also offers a "Global FICO" for many other countries. ''Credit Scores'' available online FICO scores are available online, on websites such as http://www.myfico.com, for about $45 for scores from all three bureaus. This is significantly more difficult to get and at a higher price than potential creditors pay for the same information (a loan broker is able to get all three reports with FICO scores for as little as $15 with only a name and social security number). THE PURPOSE OF A FICO SCORE A FICO score is, for the most part, a tool for those who look to obtain debt. It is almost always examined when you apply for any sort of loan in the united states; car, home, credit card, etc. It is also possible your FICO score, as well as your Credit History , will be checked when you apply for things such as cell phones, apartments, student loans, jobs, and insurance. Some financial advisers, including ''New York Times Best Seller'' author Dave Ramsey , advocate against using debt but rather use your personal income to build wealth and save for purchases. He reports that even though he is a millionare he has a "terrible credit score" (FICO score) because he has no debt. MAKEUP OF THE FICO SCORE FICO scores and its variants are designed to measure the risk of default, by taking into account various factors. Although the exact formula for calculating the FICO score is a closely guarded secret, Fair Isaac has disclosed the following components and the approximate weighted contribution of each:
The above percentages provide very 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 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, the average length of time an account has been open. Although only 35% is attribted 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 simplistic pie chart provided by Fair Isaac. Further, Fair Isaac does not use the same "scorecard" for everyone. The scorecards are segmented so that there are over 100 different actual scoring models that are applied to different individuals based on different ranges of input values (some scorecard segmentations include: age, depth of credit history, etc.). The implications of this segmentation are that while the approximate weighted contribution above may be an average across all scorecards, individuals will receive different scores or weightings based on the scorecard segmentation that they fall into. Some consumers have noticed their scores decreasing by small amounts for no apparent reason. Current income and employment history do not influence the FICO score, but they are also weighed when applying for credit. For instance, an unemployed individual with no other sources of income will not usually be approved for a home mortgage, regardless of his or her FICO score. There are other special factors which can weigh on the FICO score.
RANGE OF SCORES FICO scores range from about 300 to 850 and exhibit a Left-skewed Distribution with a US Median around 725. A score above 720 is considered to be "good credit," and a score below 600 is considered to be poor. FREE ANNUAL CREDIT REPORTS As a result of the FACT Act ( Fair And Accurate Credit Transactions Act ), each U.S. resident is entitled to one free copy of their credit report from each credit reporting agency once every twelve months. This information is available at the credit bureau-operated http://www.annualcreditreport.com . However, this report does not contain credit scores. Mostly useless consumer "credit scores", not used by any businesses, are offered for purchase at the time these reports are generated. Many other ''commercial'' websites offer free credit reports; usually these sites attempt to steer consumers to pay for related services. NON-TRADITIONAL USES OF CREDIT SCORES In September 2004 , a Texas utility company announced it would begin setting individualized electricity prices based on credit score. However, due to negative press and pressure from the Texas Public Utility Commission, the plan was not implemented. {Link without Title} Credit scores are used in determining prices for auto Insurance . Recently, some of the agencies which generate credit scores have also been generating more specialized Insurance Score s, which insurance companies then use to rate the quality of potential customers. These scores are unavailable and opaque to consumers. WAYS OF IMPROVING A FICO SCORE Since the method used to calculate the credit score is essentially just a complicated formula, one can change the score by causing changes in the variables that are important factors in the equation. There are several approaches: Credit counseling Various Credit Counseling organizations exist. Their services are often free of charge. Mortgage professionals caution that using a credit counseling service may negatively affect your credit report. Credit repair Many for-fee credit repair organizations also exist. These organizations employ less standard solutions. Many websites recommend against using credit-repair organizations, claiming that their tactics are illegal. A typical example of an illegal credit repair approach is to obtain an Employee Identification Number (EIN) and use this when applying for a credit (it is the same length as a Social Security Number and is tied to your name in the same way). This is illegal however and a blank credit report might look just as bad as one with a derogatory item on it. Some credit repair organizations claim immense improvements in scores in very short periods of time. Costs may be high and results are not usually guaranteed. Do it yourself Though professionals may have useful advice, there are a number of ways to improve your FICO score. Because the exact formula is not known, the following suggestions are not guarantees, but nevertheless are likely to result in a higher (better) score: Check credit reports for accuracy The first strategy to pursue in improving a FICO score is recommended by every credit repair organization and credit bureau. # Get your free annual reports by writing directly to the credit bureaus. # Find any inaccuracies in your reports. Credit reports are ''notoriously'' inaccurate. Check all information, not just information marked "negative. Even incorrect neutral information may weigh negatively on your report. For example, if your credit limit is stated incorrectly low, it will appear that you are using a higher percentage of your total capacity. This will lower your score. # Dispute these inaccuracies immediately. You may dispute with the creditors directly or with the bureaus. Creditors tend to have live operators while bureaus do not. Many sources recommend filing disputes with bureaus through certified "return receipt" mail. Disputes can also be filed on the credit bureau's websites, though the options are somewhat inflexible on these sites. This usually works for information that is genuinely incorrect. Punctuality It goes without saying that punctuality will improve your FICO score. Punctuality will not help in the short term, but over the course of a year, paying bills on time will increase your score by roughly 30 points, and, more importantly, will prevent your score from ''dropping''.
Cleaning up derogatory statements
Decreasing credit capacity used Decreasing the ratio of debt to credit capacity consists of two major approaches — increasing total capacity and decreasing your debt.
Establishing credit history
Minimizing damage in difficult times
Limit credit inquiries
SEE ALSO
EXTERNAL LINKS
|