Credit Scores

For decades, 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.   This is how credit scoring works in determining who gets credit.

Credit scoring is a system creditors enlist in determining 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 data. A credit scoring system gives points for each factor that helps predict who is most likely to repay a debt. The total number of points, the “credit score”, helps forecast how creditworthy you are i.e. how likely you are to repay a loan and make the payments when due.

As your credit report is an integral part of various credit scoring systems, it is important to check its accuracy before submitting a credit application.

There are three major credit reporting agencies. These agencies may charge around $9.00 for a copy of your credit report.   To obtain copies of your report, contact these three:

Equifax: (800) 685-1111

Experian : (888) EXPERIAN (397-3742)

Trans Union: (800) 916-8800

Credit scoring is based o­n real data and statistics, therefore it is considered more reliable than subjective or judgmental methods.   All applicants are treated objectively. Judgmental methods typically rely o­n criteria that are not systematically tested and can vary when applied by different individuals.

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 include 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.

How You Can Improve Your Credit 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.

Scoring models generally evaluate the following types of information in your credit report:

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.

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 will probably have a negative effect o­n your score.

How long is your credit history? Generally, models consider the length of your credit track record. A short credit history may have an effect o­n your score, but that can be offset by other factors, such as timely payments and low balances.

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 so-called preapproved credit offers are not included.

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 also consider information from your credit application: your job or occupation, length of employment, or whether you own a home.

Credit scoring systems enable creditors to evaluate millions of applicants consistently and impartially o­n many different characteristics. But to be statistically valid, credit scoring systems must be based o­n a big enough sample. These systems may vary from creditor to creditor. Although you may think such a system is arbitrary or impersonal, it can help make decisions faster.  

If you are denied credit, the Equal Credit Opportunity Act requires that the creditor give you a notice that tells you the specific reasons your application was rejected or the fact that you have the right to learn the reasons if you ask within 60 days. Indefinite and vague reasons for denial are against the law, so ask the creditor to be specific. Acceptable reasons might be: "Your income was low" or "You haven't been employed long enough." Unacceptable reasons might be: "You didn't meet our minimum standards" or "You didn't receive enough points o­n our credit scoring system."

If a creditor says you were denied credit because you are too near your credit limits o­n your charge cards or you have too many credit card accounts, you may want to reapply after paying down your balances or closing some accounts. Credit scoring systems consider updated information and change over time.

Sometimes you can be denied credit because of information from a credit report. If so, the Fair Credit Reporting Act requires the creditor to give you the name, address and phone number of the credit reporting agency that supplied the information. You should contact that agency to find out what your report said. This information is free if you request it within 60 days of being turned down for credit. The credit reporting agency can tell you what's in your report, but o­nly the creditor can tell you why your application was denied.

If you've been denied credit, or didn't get the rate or credit terms you want, ask the creditor if a credit scoring system was used. If so, ask what factors were used in that system, and the best ways to improve your application. If you get credit, ask the creditor whether you are getting the best rate and terms available and, if not, why not. If you are not offered the best rate available because of errors in your credit report, make sure you dispute the inaccurate information in your credit report in a timely manner.