The article concerns the question – What are Credit Scores. Indeed, everything we do is tracked by some monitoring device or another. Stores ask for zip codes when we shop, and rewards programs follow consumer spending through the use of the cards to gain points. Today, technology has advanced to the point of being able to track online purchases.
Clearly, whatever consumers buy, someone is tracking those purchases, and their spending habits. But, long before the internet and computer technology, credit bureaus had been collecting data about American residents in an effort to sell the information to retailers, money lenders, and other potential creditors. And what they do with that data directly impacts our daily lives.
Specifically, the information garnered from Equifax, TransUnion, and Experian, the three national credit reporting agencies in the US, is used to determine a consumer’s creditworthiness. In other words, what are the odds that a customer will make good on a loan, or default on the payments? Consumers’ habits are documented through reports that retailers and other creditors provide to the agencies.
Even utility bills might be part of the consumers’ reports. Late payments, inquiries for new credit, defaults on loans, bankruptcies, and anything to do with the use of credit, and payment of bills is listed on each person’s file. From this credit history, a credit score is created.
Credit scores are numbers derived from the statistical analysis of the paying habits of consumers. The patterns are compared with millions of other people, and a specific trend is evident. The scores are a type of prediction regarding the customer’s probable intent to pay. In other words, how likely is the consumer to pay his mortgage each month without issue? Thus, credit scores deal in the probability of a consumer’s creditworthiness.
Credit scores are created from proprietary mathematical formulas, and can be different between credit bureaus, lenders, and markets. For example, an insurance company will use a particular score to determine one’s risk as an insured. The higher the risk, the higher the premium. In terms of credit for a mortgage and other loans, the most common score used is FICO, developed by Fair Isaac Corporation, a company in California.
Interpretation of FICO Score:
FICO scores start at 300 and end at 850. Of course, the lower the number, the higher the risk, and the higher the number the better the risk. But do not be fooled because this is not like an examination at school. A score of 500 or even 600 is not necessarily considered that great. In fact, take a look at this chart to see the brief interpretation of the numbers. Please note that these are estimations and each credit agency uses the numbers a little differently.
- Poor credit is considered below 640
- Average credit is around 680 – 700
- Good credit is normally around 700
- Very good credit is above 700
As you can see, 700 on a scale that ends at 850 is not even excellent credit, but it should be good enough to receive better offers when financing.
What is Included in the FICO Scores:
Five main factors are included when calculating FICO scores.
- The biggest percentage of the equation is your payment history. On-time payments create a higher number. Defaults, late payments, and bankruptcies negatively impact the scores.
- The next factor in the equation is the total amount you owe versus your credit limits. Assume you have credit cards with limits totaling $50,000. But you have balances totaling $48,000, again this will be a negative factor. The more debt you have in relation to your limits, the lower the score.
- Moving to the next factor, the analysis looks at the length of your credit history. If you do not have any notes in the file, it will be difficult to determine a score. But, if you have had exemplary credit for twenty years, then the score will be higher.
- How often you apply for new credit is another factor. In fact, most experts recommend that if you are going to open new credit card accounts or obtain a mortgage or refinance, you should do so within a thirty day time period. This prevents your score from being lowered.
- The last factor is the type of the debt you have. For example, for someone who has had credit for many years, through credit cards, car loans, and other types of loans, the score will be increased due to diversity and longevity.
Lastly, what credit scores are not? Legally, a credit score cannot include points for and against you in relation to color, sex, race, marital status, or any other discriminatory feature. These traits cannot have numbers assigned to them. The score deals with the issues of credit and payments only.