What is a credit score?
A credit report has a lot of information on it, so you may wonder how lenders look at the credit report and make a fair decision about your credit. One way that lenders make decisions is by looking at the credit score, which is created by a computer model. Only the information in a credit report is considered. The score does not consider a person’s income, savings or amount of down payment for a mortgage. A credit score is used to predict how likely an individual is to repay a new loan based on experience with millions of consumers. A credit score is also called a FICO score.
Banks, finance companies, auto financiers, insurance companies and retailers use credit scores.
The credit score is created from several predictive variables:
Previous credit performance
A credit score predicts the future by looking at credit behavior in the last 12-24 months. Scoring considers how long it has been since the most recent 60-day (or worse) delinquency, the highest level of delinquency in the last year and the number of months since the most recent derogatory public record. The score also considers paid/unpaid collections of account, regardless of how long it has been since the collection.
Current level of indebtedness
The scoring system does not know the consumer’s debt-to-income ratio, so it considers only the level of debt. Scoring weighs heavily against credit card debt because it is an unsecured loan. If the balance on a credit card is near the limit or over the limit, the score is lowered.
Time credit has been in use
The score considers how long the consumer’s accounts have been open. The more time the scoring program has been able to track a consumer’s credit behavior, the better the score will be.
Pursuit of new credit
The score considers behaviors by looking for new credit sources. The scoring program realizes the difference between a habitual shopper and a consumer shopping for the best interest rate. If a consumer has been shopping for a car or mortgage, all respective inquiries that occur within a 30-day period will be considered as only one inquiry. After that, industry inquiries within a 14-day time span are treated as a single inquiry for the next year.
Not all credit inquiries affect the credit score. Invisible inquiries include:
- Consumers requesting a copy of their credit report.
- Promotional Inquiries (PMR) – Consumers receiving promotional credit card offers in the mail.
- Account Review Inquiries (AR) – Credit grantors reviewing their customer’s credit file. Companies review their “loan portfolio” in order to determine if they should close the account (decreased score) or increase the credit limit (increased score).
- Employment Inquiries (EMP) – Credit report pulled for employment purposes.
When certain indicators appear on a credit report, the computer program will not calculate a credit score. Those include:
- A deceased indicator on file
- Alert warning
- “File under review” – When a consumer disputes an item on the credit report with the agency, a “File under review” flag is placed on the report.
- A file with no trade lines. This means that the credit report does not show any activity between the consumer and any creditor.
- No updated trade lines in the last 6 months. The scoring program is unable to predict the future if it can’t see how a consumer has paid their bills in the last 6 months.
The scoring will not consider: child support, family support, returned checks and rental agreements.
A score will range from 250 (high risk) to 900 (low risk). You can ask for your credit score when you order a copy of your credit report. The score report typically costs about $5 in addition to the report.
A credit score will also provide information about why your score was not higher. The reason codes will give you some idea about the aspects of your credit report that lowered the score.
Some mortgage loans require certain credit scores. Be sure when you look at different loans to take note of the required credit score.
- 600 or higher, along with factors such as job stability and good credit history, should get you an "A" or FHA-type-lon.
- 500-600 means you'll pay and extra 2-3%.
- Less than 500 - WAIT! You will not get a good deal on a mortgage loan.
Information in this section was provided by Jon Clayton, Director of Educational Services at Memphis Consumer Credit Association.