What is a credit score and how does credit scoring work?
A credit score is a number that reflects your credit risk level, typically with a higher number indicating lower risk.
Credit scoring is generated through statistical models using elements from your credit report; however, your score is not physically
stored as part of your credit history on the credit file. Rather, it is typically generated at the time a lender requests
your credit report, and is then included as part of the report. Your credit score is a fluid number, and it changes as the
elements in your credit report change. For example, payment updates or a new account could cause your score to fluctuate.
There are many different credit scoring models used in the financial service industry. Your score may be different from lender to
lender (or from car loan to mortgage loan), depending on the type of credit scoring model that was used.
Why are credit scores used?
Before credit scoring models were created, lenders physically looked over each applicant's credit
report to determine whether to grant credit. A lender might deny credit based on a subjective judgment that a consumer
already held too much debt, or had too many recent late payments. Not only was this time consuming, but human judgment
was prone to mistakes and bias. Lenders used personal opinion to make a decision about an applicant that may have had
little bearing on the applicant's ability to repay debt. Credit scores help lenders assess risk more fairly because
they are consistent and objective. Consumers also benefit from this credit scoring method. No matter who you are as a person, your credit
score only reflects your likelihood to repay debt responsibly, based on your past credit history
and current credit status.
Who uses credit scores and how are they used?
Banks, credit card companies, auto dealers, retail stores, and most other lenders use scores to quickly summarize a consumer's credit history, saving the need to manually review
an applicant's credit report and provide a better, faster risk decision. Although many additional factors are used in
determining risk, such as an applicant's income vs. the size of the loan, a credit score is a leading indicator of
one's basic creditworthiness.
What information impacts my credit score?
The information that impacts a credit score varies depending on the score
being used. Generally, credit scores are affected by elements in your credit
report, such as:
- Number and severity of late payments
- Type, number and age of accounts
- Total debt
- Recent inquiries
-based scores, like those generated by Experian, cannot use demographics prohibited under the Equal
Credit Opportunity Act, such as race, color, religion, national origin, gender, age, marital status, receipt of public
assistance or exercise of rights under Consumer Credit Protection Act. Scores used by individual lenders may use such
elements as income, occupation, and type of residence for credit scoring and determining their own custom credit score.
Credit scoring 101
History of credit scores
Credit scores became widely used in the 1980's. Long before credit scoring, human judgment was the sole
factor in deciding who received credit. Lenders used their past experience at observing consumer credit behavior
as the basis for judging new consumers. Not only was this a slow process, but it was also unreliable because of
human error. Lenders eventually began to standardize how they made credit decisions by using a point system that
scored the different variables on a consumer's credit report. This point system helped to eliminate much of
the bias that previously existed; however, it was still tied to intuitive measures of credit worthiness and was
not based on actual consumer behavior. Credit granting took a huge leap forward when credit scoring statistical models were built
that considered numerous variables and combinations of variables. These models were built using payment information
from thousands of actual consumers, which made scores highly effective in predicting consumer credit behavior. When
combined with computer applications, credit scoring models have made the credit granting process extremely fast, efficient
and objective, facilitating commerce and helping consumers quickly get the credit they need.
The credit modeling process
Designers of credit scoring models review a set of consumers - often over a
million - who opened loans at the same time, and determine who paid their loan and who did not. The credit profiles
of the consumers who defaulted on the loans are examined to identify common variables they exhibited at the time they
applied for the loan. The designers then build statistical models that assign weights to each variable, and these
variables are combined to create a credit score. Credit scoring models for specific types of loans, such as auto or home, more
closely consider consumer payment statistics related to these loans. Model builders strive to identify the best
set of variables from a consumer's past
credit history that most effectively predict future
In determining credit scores, lenders place you in a risk category that
compares you to a large number of consumers with similar credit histories. This allows lenders to compare "apples to
apples," ensuring that your credit behavior is judged in a context that is relevant and fair. For example, consumers
with brief credit histories and only a few accounts are not compared to consumers with long-established credit
histories. Rather, these consumers will be compared to other consumers who also have brief credit histories.
Keep in mind that the attributes of your risk category (i.e. number of accounts, total debt, etc.) may not have
the same impact to a credit score for consumers in another risk category.
What are score factors?
Score factors are the elements from your credit report
that drive your credit score. For example, such elements as
your total debt, types of accounts, number of late payments and age of accounts are what determine the outcome of your
credit score. Score factors can have a positive or negative affect on your credit score. Lenders must provide consumers
with the most significant score factors when they are declined credit.
Your credit score
How can I see my credit score?
Lenders, especially mortgage lenders, often make credit scores available to consumers during the home loan
they are under no obligation to do so. However, there is a good possibility that consumers will soon have the benefit of
new disclosure laws concerning credit scores. For example, the state of California recently passed a law that will obligate
mortgage lenders to reveal credit scores to loan applicants beginning in July 2001. Industry analysts expect other states to
follow suit. To get access to your PLUS score, credit report and other membership benefits right now, sign up for
freecreditreport.com™ Credit Monitoring
Why don't I have a credit score?
Credit scoring models cannot generate a
score without sufficient credit information. If you have little or no credit history, you will probably not have a credit
How often does my credit score change?
Your credit score is a fluid number
that changes as your credit report changes. Therefore, any change to your credit report could impact your score. Learn more about how to build your credit history.
How do my spouse or other family members affect my credit?
If you hold a joint credit account, have co-signed a loan or have authorized use of another person's credit,
these items could affect your score if they appear on your credit report. It's important that joint account holders
or authorized users understand that their credit behavior does affect the other joint account holder or main account
holder. A credit account held solely in the name of your spouse, child or any other family member cannot impact your
credit score. However, in community property states, all debt acquired during a marriage is considered a joint debt,
regardless if the account is joint or in the name of an individual spouse. Find out more about Credit Card Debt after Divorce.