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Credit Scoring
To improve your credit score under most models, concentrate on paying your
bills on time, paying down outstanding balances, and not taking on new debt.
Over a period of time it's likely
to improve your score significantly.
Ever wonder how a creditor decides whether to
grant you credit? For years, creditors have been using credit scoring systems to determine
if you'd be a good risk for credit cards and auto loans. More recently, credit scoring has
been used to help creditors evaluate your ability to repay home mortgage loans. Here's how
credit scoring works in helping decide who gets credit -- and why.
What is credit scoring?
Credit scoring is a system creditors use to help determine whether to give you credit.
Information about you and your credit experiences, such as your bill-paying history,
the number and type of accounts you have, late payments, collection actions, outstanding
debt, and the age of your accounts, is collected from your credit application and your
credit report. Using a statistical program, creditors compare this information to the
credit performance of consumers with similar profiles. 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, that is, how
likely it is that you will repay a loan and make the payments when due.
Because your credit report is an important part of many credit scoring systems, it is
very important to make sure it's accurate before you submit a credit application. To get
copies of your report, contact the three major credit reporting agencies:
These agencies may charge you up to $9.00 for your credit report.
Why is credit scoring used?
Credit scoring is based on real data and statistics, so it usually is more reliable than
subjective or judgmental methods. It treats all applicants objectively. Judgmental methods
typically rely on criteria that are not systematically tested and can vary when applied by
different individuals.
How is a credit scoring model developed?
To develop a model, a creditor selects a random sample of its customers, or a sample of
similar customers if their sample is not large enough, and analyzes it statistically to
identify characteristics that relate to creditworthiness. Then, each of these factors is
assigned a weight based on how strong a predictor it is of who would be a good credit
risk. Each creditor may use its own credit scoring model, different scoring models for
different types of credit, or a generic model developed by a credit scoring company.
Under the Equal Credit Opportunity Act, a credit scoring system may not use certain
characteristics like -- race, sex, marital status, national origin, or religion -- as
factors. However, creditors are allowed to use age in properly designed scoring systems.
But any scoring system that includes age must give equal treatment to elderly applicants.
What can I do to improve my score?
Credit scoring models are complex and often vary among creditors and for different types
of credit. If one factor changes, your score may change -- but improvement generally
depends on how that factor relates to other factors considered by the model. Only the
creditor can explain what might improve your score under the particular model used to
evaluate your credit application.
Nevertheless, scoring models generally evaluate the following types of information in
your credit report:
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Have you paid your bills on time? Payment history typically is a significant
factor. It is likely that your score will be affected negatively if you have paid bills
late, had an account referred to collections, or declared bankruptcy, if that history is
reflected on your credit report.
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What is your outstanding debt? Many scoring models evaluate the amount of debt
you have compared to your credit limits. If the amount you owe is close to your credit
limit, that is likely to have a negative effect on your score.
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How long is your credit history? Generally, models consider the length of your
credit track record. An insufficient credit history may have an effect on your score, but
that can be offset by other factors, such as timely payments and low balances.
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Have you applied for new credit recently? Many scoring models consider whether
you have applied for credit recently by looking at "inquiries" on your credit
report when you apply for credit. If you have applied for too many new accounts recently,
that may negatively affect your score. However, not all inquiries are counted. Inquiries
by creditors who are monitoring your account or looking at credit reports to make
"prescreened" credit offers are not counted.
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How many and what types of credit accounts do you have? Although it is
generally good to have established credit accounts, too many credit card accounts may have
a negative effect on your score. In addition, many models consider the type of credit
accounts you have. For example, under some scoring models, loans from finance companies
may negatively affect your credit score.
Scoring models may be based on more than just information in your credit report. For
example, the model may consider information from your credit application as well: your job
or occupation, length of employment, or whether you own a home.
Credit
Scoring Continued
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