Part of everyday life in the consumer credit industry is about credit and credit scores. We look at our potential customers based on their repayment capacity, and nothing measures that capacity as well as the customer’s credit rating. So what exactly are the factors that go into formulating the score?
FICO, formerly known as Fair Isaac & Company, is the primary credit score provider. About 90% of credit decisions are based on the FICO score. Their scale goes from a minimum of 300 to a maximum of 850. The bands are as follows:
- 300 to 579 – Bad
- 580 to 669 – Medium
- 670 to 739 – Good
- 740 to 799 – Very good
- 800 to 850 – Exceptional
So how can national credit bureaus (Experian ™, TransUnion ™ and Equifax ™) come up with different FICO scores for the same person? To answer this question, let’s look at their rating categories.
Experian ™, for example, uses five categories and assigns them a different weight:
- Payment history is weighted at 35%. This category includes the number of missed payments, recoveries and derogatory information from public records. Recent credit card usage is also taken into account here. The more frequent the late payments, the greater the negative impact on the score.
- The amount of debt is weighted at 30%. The use is really important. It might seem counterintuitive, but if you owe little, have few accounts, and have a lot of available credit, it may not be a good clue.
- The length of the credit history is weighted at 15%. The duration of the accounts, the age of the oldest and most recent accounts and the average age of all accounts are taken into account here.
- The amount of the new loan is weighted at 10%. The number of new accounts recently opened is a factor. Opening new credit accounts in a short period of time is an indicator of greater credit risk.
- The credit composition is weighted at 10%. Examples of types of credit include revolving, bank-issued credit card accounts and installment loans, including mortgages. The credit mix becomes important when the agency does not have a lot of other information.
The differences in the credit scores of the credit bureaus come from the differences in the “ingredients” and the different weights they may assign. This is their proprietary information, their secret sauce. Interestingly, there are tutorials online that can help consumers increase their credit score by a few points. Sometimes a few points will be enough to switch to another strip.
It is important that each of us, as consumers, know our credit scores and check them periodically. After all, the better our score, the better our purchasing power, at least in terms of what creditors are willing to finance at a good rate.
Practice pointer # 1: Check your credit score by clicking on Sign Up (experian.com), Online Personal Credit Reports & Credit Scores – TransUnion Credit Monitoring or Monthly Credit Score and Report | Equifax ™ Basic Credit | Equifax®.
Practice pointer # 2: For more information from Back to the roots on credit scores and consumer debt, click here.