information

Credit Score

What is it...

The scoring model system came into being about nine years ago. The Fair, Isaac Company, developed it a computer software designer (hence the acronym "FICO").

The scoring system is licensed out to The Big Three credit repositories, which in turn call it by individual names to help differentiate which repository is issuing which score. Experian calls their score a FICO; Equifax calls theirs the Enhanced Beacon; and Transunion calls theirs the Empirica Model.

The score that each repository issues on their individual reports is a reflection of the information that repository has on an individual in their respective credit files. So, the score issued by each repository will usually be different from the other repository's scores. The primary repository will usually have the most accurate score, and if the borrower has had any credit problems over the past few years, the primary repository will usually have the lowest credit score.

However, it will sometime work in reverse - if the borrower has recently cleaned up his credit history, the primary repository will usually have the most accurate updates, and in that case, the primary repository may likely show the highest score.

You can look at two different repository's reports on a borrower, and in reviewing the credit profiles; you usually can see what differences in the credit information are likely causing the different scores.

How It Works

Using a complex matrix measuring over 30 different variables in an individual's credit profile, the Fair, Isaacs program converts the profile into a numeric score which is added to an individual's credit report. That score is a reflection of the computer assigned credit risk for that individual. The intent is to reduce the amount of subjectivity credit decision makers (underwriters) inject into the risk analysis process. The most important variables for mortgage loans are as follows:

Mortgage history
Derogatory Credit History
Liens or Judgements
Length of Credit History
Depth of Credit History
Proportion of Debt to Credit Balances
Amount of Available Credit

Generically speaking, the scores can run from 0 to 1,000. The highest I have ever seen is an 863. However, it is generally accepted that anyone with a 700 credit score is A credit, and over 720 is AA credit. Individual lenders technically assign their own credit grades to the credit scores, but between various lenders they are usually pretty close as to what score constitutes what grade. Here is an approximation of the credit score/grade:

Score Credit Grade
720 and up AA
700 to 719 A
680 to 699 A-/B+
660 to 679 B+/B
640 to 659 B
620 to 639 B-/C+/C
600 to 619 C/D
580 to 599 D/F
579 and below F

It is important to recognize that these scores are not just about derogatory credit history. They are about determining credit risk associated with a particular borrower, and points are added or taken away based on many different factors related to your credit profile.

For example, once you begin start using credit accounts, you are usually going to have a credit score in the 565 to 580 range. Why so low? Well, you are just starting out, and you have no credit history to rate. Once you have 12 months of usage on your accounts, you will begin adding points to your credit history. Or if you mess up, you will destroy your credit quickly, and then you really face a tough uphill climb.

You are considered high risk when you start out, because you haven't really proven yourself yet. As you slowly build credit over a year's time, your score will start climbing. But now the paradox sets in. Each time you add a new credit account to your history, your score will drop. Why? Because you have added more debt to your credit load. However, once you have shown the ability to handle the new debt as well, your score will recover, usually in about six months. Once you have a 12-month rating on the new account, you will start having points added to your credit score.

Over time, you build your credit up by scoring points. To score points, you have to use credit, and your creditors have to report your accounts to the credit bureaus. Having a $200 tab at a local restaurant won't help you a bit, no matter how good your payment record is.

You also have to pay your bills on time. Every time you show a late pay, you lose points, and it takes an awful long time to recover them. Once you show 36 months of timely payment history on any account, you are earning the maximum points. Generally speaking, you will have an excellent credit score when you have four major accounts ($1,500 credit limits or higher) all with 36 months spotless payment history, and all usually maintaining balances that are at or below 60% of your available credit limits.

A mortgage rating will boost your score even further. You start collecting points on a mortgage at 12 months, and max out at 36 months. Obviously, this too is where you will lose the most points if you have any late pays on your mortgage history, and where it takes you the longest to recover any lost points.

Where you see scores in the 770 and up range, you will usually see about 8 to10 years history, with 3 to 4 revolving credit accounts that are rarely maxed out, a sterling mortgage history, and two or more major installment accounts (like car loans/leases) that have been paid off. If the report shows any late pays, it was likely a 30 day, one time, on a revolving account, over three years ago.

How about the guy who never misses a payment, always pays on time, and still only has a 640 credit score? Well, if he uses a lot of credit, it could be that he has too many accounts, and he carries high balances (over 60%) in relation to the credit limits. Or he could be making too many minimum monthly payments, instead of sizable payments. Or yesterday he had a 685 score, but today he has a new $25,000 credit card, with a new $20,000 balance on it. Or he has good credit, but he only has four accounts, no mortgage history, and three of the accounts are less than 24 months old.

The scoring model has weighted adjustments as well. The guy who has a strong credit history, and a lot of depth in his credit report, and blip... there pops up a 30 day late. Well, it's been 60 days since, and the late pay wasn't on a mortgage or a car loan, so he's probably going to lose about 3 points on his credit score. If it was a mortgage or a car loan, he will lose about 10 points.

The guy with the 660 score? He's probably going to lose about 10 points on a revolving account late... if it's a mortgage or car loan, he might lose as much as 20 points. At 620, the revolving late will cost him15 to 20 points, and a mortgage or car late could cost him a 30-point reduction in his score.

See, a computer can't tell if you are a deadbeat, or under financial strain, or just nonchalant about paying your bills on time. And it really doesn't matter what the reason is. All the computer knows is that if your score was already low, and you are making late payments, you are a credit risk - by giving you a low score, indicating you are a high credit risk, the credit report tells the next guy to loan you money that he is probably going to regret it!

Reliability of Scoring Models

For a lot of people, it doesn't seem fair. But the truth is, with the advent of the scoring models, more people can borrow more money than ever before. Risk analysis has become more quantifiable, and lenders are more confident now with the predictability factors in their loan portfolio management. Thus, they are comfortable offering more loan programs, and managing the risk by adjusting the interest rates and loan to value ratios according to credit score.

The models aren't perfect, and a lot of mistakes still occur. But there has been extensive research and verification on the reliability of the scoring models, by heavyweights such as FNMA and FHLMC. The research holds up. If you are a 640 FICO, you are a greater risk than a 700 FICO individual. You personally may never have a problem on a new loan, but of all the loans that lender made to 640 FICO borrowers; he knows he is going to have a higher default rate that on the pool of loans he made to 700 FICO borrowers.

More than that, he knows approximately what the percentage rate difference of the defaults is going to be between the two groups, and he will adjust his interest rates to make up for the higher losses he is going to absorb for the lower scoring group. He has no way of knowing if it will be you, or the other 640 FICO individuals who default... only that it will happen at a higher rate than 700 FICO defaults. And of course, if you are a 600 FICO, the risk you pose more than doubles.

Now here's the fun part. Figuring out where you rate in terms of credit grade. For a car dealer, if you have two decent lines of credit, and you had a couple of payment problems over two years ago, but you have been clean since, even though your score is a 585, he's going to get you a loan. To build you up, he tells you that you have "A" credit, so you are not paying as much attention to the financing being at 14.99% instead of the 8.99% that a real "A" borrower is getting. And not knowing any better, you go out the door thinking you are an "A" credit borrower.

Same thing with some of the consumer loan companies, or electronics stores, carpet stores, furniture stores and so forth that either carry their own financing, or have profit sharing arrangements with consumer finance companies. It is worth keeping in mind that these types of companies can easily repossess the goods, or come after you in court, without a great deal of risk in terms of loss. It's a lot easier to get credit from those kinds of lenders.

Same things with credit card offers. But, these scores can make a big difference in the card offers you receive, what kind of credit limits they will ultimately give you, and what kind of interest rates they are going to charge - both introductory and long term.

If you have a 700 FICO score, everybody wants your business, and you are going to find your mailbox stuffed with credit card offers all the time. You are also going to see a lot of 2.9% and 3.9% promotional rates for as long as 12-month periods, $10,000 to $25,000 credit lines, and long term fixed rates as low as 7.99%

If you are in the 660 to 699 range, you're mailbox is going to be stuffed too... and you'll probably see a lot of six month 2.9% to 3.9% introductory offers as well. But you'll likely see most of your long-term rates hovering in the 12.99% to 15.99% range.

Chances are, you'll still see a lot of credit card offers in the 620 to 659 range, but you are going to be getting mostly generic standard high rate credit card offers. Some will offer you 3.9% introductory rates, but most of them will be for about three months or so, and then the card cranks up to 17.99% or higher, on a variable rate basis.

From 600 to 619, you'll still get quite a few offers too, but not too many low introductory offers. You might even get one or two that might offer you up to a $5,000 credit limit, but most will be in the $1,000 to $3,000 range, and you'll be starting right out at the 17.99% and up variable rates.

With a 580 to 599 credit score, you'll be seeing a lot of offers too - but they will be for $500 to $1,000 credit lines, no introductory low rate offers, and most will be starting out in the 19.99% and up variable interest rate range. Many of the offers will be for secured cards - in other words, to get the card, you have to post a savings account deposit with the card issuer, and you will only get a credit limit equal to your deposit. Most of these plans limit you to $500 until you show a 12-month rating on the account.





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