Credit Score
What is credit scoring? Credit scoring is a system
creditors use to help determine whether to give you credit.
It also may be used to help decide the terms you are
offered or the rate you will pay for the loan. Information
about you and your credit experiences, like your
bill-paying history, the number and type of accounts you
have, whether you pay your bills by the date they’re
due, collection actions, outstanding debt, and the age of
your accounts, is collected from your credit report. Using
a statistical program, creditors compare this information
to the loan repayment history of consumers with similar
profiles. For example, a credit 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 creditworthy you are
— how likely it is that you will repay a loan and
make the payments when they’re due.
Some insurance companies also use credit report
information, along with other factors, to help predict your
likelihood of filing an insurance claim and the amount of
the claim. They may consider these factors when they decide
whether to grant you insurance and the amount of the
premium they charge. The credit scores insurance companies
use sometimes are called “insurance scores” or
“credit-based insurance scores.” Credit scores
and credit reports
Your credit report is a key part of many credit scoring
systems. That’s why it is critical to make sure your
credit report is accurate. Federal law gives you the right
to get a free copy of your credit reports from each of the
three national consumer reporting companies once every 12
months. The Fair Credit Reporting Act (FCRA) also gives you
the right to get your credit score from the national
consumer reporting companies. They are allowed to charge a
reasonable fee, generally around $15, for the scores. When
you buy your scores, often you get information on how you
can improve it. How is a credit scoring system developed?
To develop a credit scoring system or model, a creditor or
insurance company selects a random sample of its customers,
or a sample of similar customers, and analyzes it
statistically to identify characteristics that relate to
risk. Each of the characteristics then is assigned a weight
based on how strong a predictor it is of who would be a
good risk. Each company may use its own scoring model,
different scoring models for different types of credit or
insurance, or a generic model developed by a scoring
company. Under the Equal Credit Opportunity Act (ECOA), a
creditor’s scoring system may not use certain
characteristics — for example, race, sex, marital
status, national origin, or religion — as factors.
The law allows creditors to use age in properly designed
scoring systems. But any credit scoring system that
includes age must give equal treatment to elderly
applicants.
What can I do to improve my score? Credit scoring systems
are complex and vary among creditors or insurance companies
and for different types of credit or insurance. If one
factor changes, your score may change — but
improvement generally depends on how that factor relates to
others the system considers. Only the business using the
scoring knows what might improve your score under the
particular model they use to evaluate your application.
Nevertheless, scoring models usually consider the following
types of information in your credit report to help compute
your credit score: Have you paid your bills on time? You
can count on payment history to be a significant factor. If
your credit report indicates that you have paid bills late,
had an account referred to collections, or declared
bankruptcy, it is likely to affect your score negatively.
Are you maxed out? Many scoring systems evaluate the amount
of debt you have compared to your credit limits. If the
amount you owe is close to your credit limit, it’s
likely to have a negative effect on your score.
How long have you had credit? Generally, scoring systems
consider the length of your credit track record. An
insufficient credit history may affect your score
negatively, but factors like timely payments and low
balances can offset that. Have you applied for new credit
lately? Many scoring systems consider whether you have
applied for credit recently by looking at
“inquiries” on your credit report. If you have
applied for too many new accounts recently, it could have a
negative effect on your score. Every inquiry isn’t
counted: for example, inquiries by creditors who are
monitoring your account or looking at credit reports to
make “prescreened” credit offers are not
considered liabilities. How many credit accounts do you
have and what kinds of accounts are they? Although it is
generally considered a plus to have established credit
accounts, too many credit card accounts may have a negative
effect on your score. In addition, many scoring systems
consider the type of credit accounts you have. For example,
under some scoring models, loans from finance companies may
have a negative effect on your credit score. Scoring models
may be based on more than the information in your credit
report. When you are applying for a mortgage loan, for
example, the system may consider the amount of your down
payment, your total debt, and your income, among other
things. Improving your score significantly is likely to
take some time, but it can be done. To improve your credit
score under most systems, focus on paying your bills in a
timely way, paying down any outstanding balances, and
staying away from new debt.
Are credit scoring systems reliable? Credit scoring systems
enable creditors or insurance companies to evaluate
millions of applicants consistently on many different
characteristics. To be statistically valid, these systems
must be based on a big enough sample. They generally vary
among businesses that use them. Properly designed, credit
scoring systems generally enable faster, more accurate, and
more impartial decisions than individual people can make.
And some creditors design their systems so that some
applicants — those with scores not high enough to
pass easily or low enough to fail absolutely — are
referred to a credit manager who decides whether the
company or lender will extend credit. Referrals can result
in discussion and negotiation between the credit manager
and the would-be borrower.
What if I am denied credit or insurance, or don’t get
the terms I want? If you are denied credit, the ECOA
requires that the creditor give you a notice with the
specific reasons your application was rejected or the news
that you have the right to learn the reasons if you ask
within 60 days. Ask the creditor to be specific: Indefinite
and vague reasons for denial are illegal. Acceptable
reasons might be “your income was low” or
“you haven’t been employed long enough.”
Unacceptable reasons include “you didn’t meet
our minimum standards” or “you didn’t
receive enough points on our credit scoring system.”
Sometimes you can be denied credit or insurance — or
initially be charged a higher premium — because of
information in your credit report. In that case, the FCRA
requires the creditor or insurance company to give you the
name, address, and phone number of the consumer reporting
company that supplied the information. Contact the company
to find out what your report said. This information is free
if you ask for it within 60 days of being turned down for
credit or insurance. The consumer reporting company can
tell you what’s in your report; only the creditor or
insurance company can tell you why your application was
denied. If a creditor or insurance company says you were
denied credit or insurance because you are too near your
credit limits on your credit cards, you may want to reapply
after paying down your balances. Because credit scores are
based on credit report information, a score often changes
when the information in the credit report changes.
If you’ve been denied credit or insurance or
didn’t get the rate or terms you want, ask questions:
Ask the creditor or insurance company if a credit scoring
system was used. If it was, ask what characteristics or
factors were used in the system, and how you can improve
your application. If you get the credit or insurance, ask
the creditor or insurance company whether you are getting
the best rate and terms available. If you’re not, ask
why. If you are denied credit or not offered the best rate
available because of inaccuracies in your credit report, be
sure to dispute the inaccurate information with the
consumer reporting company.
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