Credit score (United States)

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In the United States, a credit score is a number that is based on a statistical analysis of a person's credit report, and is used to represent the credit worthiness of that person—the likelihood that the person will pay his or her debts. A credit score is primarily based on credit report information, typically from the three major credit bureaus: Equifax, Experian, and TransUnion. There is no single credit score for any one person because each of the three credit bureaus has different information in its credit files for each person, and there are many different credit scoring models in use. Many lenders use third-party credit scoring systems, such as Fair Isaac's FICO scoring model, to evaluate the creditworthiness of a borrower. While the terms credit score and FICO score are synonymous in many people's minds, in actuality a FICO score is a credit score calculated using one particular credit scoring system.

Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Using credit scores, lenders determine who qualifies for a loan, at what interest rate, and to what credit limits. While the most widely known score in the United States is FICO (the most widely used in the mortgage industry), there are many others, such as NextGen, VantageScore, and the CE Score.

The Fair Isaac corporation created the first credit scoring system in 1958 for American Investments and the first credit scoring system for a bank credit card in 1970 for American Bank and Trust.[1] Because a score does not consider race, sex or ethnicity, it is generally considered to be the most fair and objective underwriting tool available to lenders.

Contents 1 FICO score 2 Credit reporting agencies 3 NextGen score 4 VantageScore 5 Score facts 6 Makeup of the credit score 7 Range of scores 8 Free annual credit reports 9 Non-traditional uses of credit scores 10 Criticisms and Controversies 11 References 12 See also 13 External links

FICO score

FICO scores are usually intended to show the likelihood that a borrower will default on a loan; a separate score, the BNI, is used to determine the likelihood of a borrower's declaring bankruptcy. Each credit bureau also calculates a credit score (not a FICO score) using its own proprietary model which differs from the model used by Fair Isaac Corporation.^[1] It is not unusual for these scores to differ—by 50^[1](or 100^[2]) points or more—for the same borrower. For the three types of credit for which a FICO score is generally used (mortgages, automobile loans, and consumer credit), lenders usually establish different cut-offs for lending,^[3] reflecting the loan default risks inherent to these different types of lending. The score also depends on what credit reporting agency the data are obtained from, since not all creditors report to all three. The score Fair Isaac sells to borrowers is their consumer credit score, and borrowers can choose the agencies from which scores will be calculated.^[1]

Credit reporting agencies

In the U.S., three credit reporting agencies, Equifax, Experian, and TransUnion, calculate a borrower's credit score using their own different computation formulas. The scores they generate (with trademarked names), differ in what they mean to predict, the statistical methods used to determine a creditworthiness score, and what data are used and how they are weighted. Beacon, Beacon 5.0, Beacon 96, and Pinnacle scores are available only from Equifax; Empirica, Empirica Auto 95, Precision Score, and Precision 03 from TransUnion; and the Fair Isaac Risk Score is available from Experian. Although the Fair Isaac Corporation develops these credit score versions for the different agencies, they are different numbers, although they derive from a common engine called the Fair Isaac Risk Model. These scores are periodically updated to reflect current consumer loan repayment rates.

NextGen score

The NextGen Score is a scoring model designed for assessing consumer credit risk. It is similar to the traditional FICO scores with regard to intended use and general design. It has not enjoyed the same level of adoption as the traditional FICO score, but is used by some creditors. Other credit consumer scores are published by MyFICO.com and by Community Empower, as the CE Score.

VantageScore

In 2006, in attempting to make scoring consistent, the three major credit-reporting agencies introduced VantageScore. VantageScore uses a number range (501 to 990), which is different from FICO's, and assigns letter grades (A to F) to specific score ranges. A borrower's VantageScore may differ from agency to agency, but discrepancies stem from data differences in the reported credit information, not because of differences among credit-scoring mathematical models. Since FICO remains as the widely-used score by money lenders, the agencies continue offering FICO scores or similar.

Score facts

Template:Original research Most scores use a multiple-scorecard design. Each version may use individual scorecards. Typically, a given borrower is compared with other consumers; e.g., a borrower with two 30-day late payments will be scored against a similar delinquent-payer population. The borrower then is graded according to the risk-determining mathematical variables used by the scoring model, ranking him or her within the group of similar borrowers. Most large banks build and use their own proprietary statistical credit-scoring models, often in conjunction with third-party scoring models.

The statistical models for generating credit scores are subject to federal regulation. The Federal Reserve Board's Regulation B (implementing the Equal Credit Opportunity Act), expressly prohibits a credit-scoring model considering "prohibited biases" such as race, religion, national origin, sex, and marital status. It also states that credit-scoring models must be empirical and statistically sound. Furthermore, if negative action results from a credit score (i.e. a denied application for credit), the lender must state to the borrower the specific reasons for the denial. A statement that the person "failed to score high enough" is insufficient; the reasons must be specific (e.g. "too many delinquencies of 60 days or greater").

There are several generally-accepted algorithms for extrapolating the primary factors generating a low credit score. Typically, one or more of these algorithms is used to list reasons for when a loan applicant is denied credit, in satisfaction of the Regulation B requirement that specific reasons be given to the applicant. These reasons are often specified using a reason code that is more-or-less standardized across scoring models.

For easy use, most scores are mathematically scaled so that they fall in the general range used by prominent scoring model competitors. Since the Fair Isaac provides the dominant scoring method; non-Fair-Isaac scores often mimic FICO scores (and are frequently derisively referred to as "FAKO" scores).[5] Although not as widely used, these scores (e.g. TransUnion's "TransRisk", Experian's "ScoreX", and "PLUS" scores), are less expensive to buy than is the FICO score. The business cost savings of buying and using non-FICO scores is financially tempting to some banks and credit card companies to use, as they need accurate risk assessment of millions of accounts.

The Fair Isaac Corp. offers scoring models for the U.S., Canada, and South Africa, and offers a Global FICO score for other countries.

Makeup of the credit score

Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulas for calculating credit scores are closely-guarded secrets, the Fair Isaac Corporation has disclosed the following components and the approximate weighted contribution of each: [6]

• 35% — punctuality of payment in the past (only includes payments later than 30 days past due)
• 30% — the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
• 15% — length of credit history
• 10% — types of credit used (installment, revolving, consumer finance)
• 10% — recent search for credit and/or amount of credit obtained recently

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 and the average length of time other accounts have been open. Although only 35% is attributed to punctuality, if a consumer is substantially late on numerous accounts, his or her score could fall far more than 35%.[citation needed] Bankruptcies, foreclosures, and judgments affect scores substantially, but are not included in the somewhat simplistic pie chart provided by Fair Isaac.

Credit scores are not the sole underwriting factor used by lenders. Other loss mitigation tools and data are used in addition to a score to gauge an individual's creditworthiness. For instance, current income and employment history, which are not part of a score, are weighed when applying for credit, along with tenancy status (rent or own) in some cases. An unemployed individual with no 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.

• Any money owed because of a court judgment, tax lien, or similar carry an additional negative penalty, especially when recent.
• Having more than a certain number of consumer finance credit accounts also carries a negative weight (critics say that this causes a vicious cycle, locking people into continuing to use consumer finance companies).[citation needed]
• The number of recent credit checks also can weigh down the score, although credit agencies usually claim to allow for credit checks made within a certain window of time (the so-called de-dupe period) not to aggregate, so as to allow the consumer to shop around for rates.[citation needed]. While all credit inquiries are recorded and displayed on your credit report for a period of time, credit inquiries that were made yourself (to check your credit), by your employer (for employee verification) or by companies initiating prescreened offers of credit or insurance do not have any impact on your credit score.

[edit] Range of scores

Range of scores

A FICO score is between 300 and 850, exhibiting a left-skewed distribution with 60% of scores between 650 and 799.^[4] According to Fair Isaac the median score is 723 (half of scores above and below) whereas according to Experian (using the Fair Isaac risk model) the average credit score is 678 (lowest scores are further from the median than the highest scores). The performance of the scores is monitored and the scores are periodically aligned so that a credit grantor normally does not need to be concerned about which score card was employed.

Each individual actually has three credit scores for any given scoring model because the three credit agencies have their own databases. As these databases are independent of each other, they may contain entirely different data. Many lenders will check an applicant's score from each bureau and use the median score to determine the applicant's creditworthiness.

VantageScore ranges from 501 to 990 and offers letter grades as well: A (901-990), B (801-900), C (701-800), D (601-700), and F (501-600).

Free annual credit reports

As a result of the FACT Act (Fair and Accurate Credit Transactions Act), each legal U.S. resident is entitled to one free copy of his or her credit report from each credit reporting agency once every twelve months, although some states permit one free copy every six months. This information is available at the only government-mandated credit reporting agency-operated website, annualcreditreport.com, by calling 1-877-322-8228, or by mailing the Annual Credit Report Request Form. To guard against inaccurate information or fraud more often than yearly, one can request a report from a different credit reporting agency each four months. However, the free report does not contain a credit score, though a credit score may be purchased at the time of access.

To prevent all three credit bureaus from making your address available for "prescreened" offers of credit, you may opt out by calling 1-888-5-OPT-OUT (1-888-567-8688) or by visiting their website optoutprescreen.com.

Non-traditional uses of credit scores

Credit scores are often used in determining prices for auto and homeowner's insurance. Recently, some of the agencies that generate credit scores have also been generating more specialized insurance scores, which insurance companies then use to rate the quality of potential customers. These scores are unavailable to consumers.

In September 2004, TXU (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.

Some employers, especially financial institutions, will request permission from job applicants to run a credit check as part of their application process. This credit information can be used as an indicator of a person's level of financial responsibility. Note that job applicants have certain rights under the Fair Credit Reporting Act and are not required to consent to a credit check.

Criticisms and Controversies

Credit scores can be adversely affected if the information in a credit report is not updated by a lender. Lenders and others that furnish credit information to a credit bureau usually update it every month. If the data furnisher does not report to the bureau that debt has been reduced or paid off, it will stay on the credit report until the debtor finds the error and reports the updated status themselves.

Some lenders will intentionally delay updates to consumers' files (especially if they are ameliorative): positive actions, such as pay-downs that lower account utilization, may not be reflected in the file until late in the following billing cycle in order to overrepresent risk. The lender could then use the exaggerated risk profile of the consumer to justify adverse actions like increasing interest rates and curtailing credit lines until the file has been updated.

It is relatively easy to "doctor" a person's credit score to increase it. Because a major portion of the FICO score is determined by the ratio of credit used to credit limit, a simple way to increase the score is to simply increase your credit limit. Some agencies, for a fee, will report to credit bureaus that they have opened an account with a high credit limit. The customer cannot actually use this account, but it improves the customer's FICO score due to lowering the balance-to-credit-limit ratio.^[5]

According to a Fitch study, the accuracy of FICO in predicting delinquincy has reduced in recent years. In 2001 there was an average 31-point difference in the FICO score between borrowers who had defaulted and those who paid on time. By 2006 the difference was only 10 points. Meredith Whitney of CIBC World Markets has called the FICO score "virtually meaningless". Golden West Financial has reduced its reliance on FICO scoring, and now does a more costly analysis of a potential borrower's assets and employment before giving a loan. According to Richard Atkinson of Golden West "some of our best borrowers had low FICO scores and our worst had FICO scores of 750".^[5]

The FICO scoring system is being tweaked in 2008 with the introduction of FICO 08, which Fair Isaac claims should improve the accuracy of the score and remove some of the problems.^[5]

References

See also

• Credit score, international article

External links

• US Government FAQ about FACT
• Text of Regulation B, which stipulates the conditions that US credit scoring models must satisfy
• PBS FRONTLINE "Credit Scores: What You Should Know About Your Own," by Malgorzata Wozniacka and Snigdha Sen (November 2004)