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Credit Scores - All You Wanted to Know but didn't know whom to Ask
What is a Credit Score?
A credit score is a computation of your credit worthiness as calculated by credit reporting bureaus. The information on which the score is based is gathered from your credit report, which has been prepared by credit bureaus on the basis of information provided to them from various sources.
The most common and widely used score with respect to individuals is the FICO score developed by the Fair Isaac Corporation.
An example of business credit scores is the Paydex score from Dun & Bradstreet. Another score is the Experian Intelliscore. Dun and Bradstreet also provide the DUNS rating
What are Credit Bureaus?
Credit bureaus are organizations involved in the collection and organization of credit information supplied to them by various lenders, credit institutions, and other agencies involved in utilization of public finance. They also get their information from collection agencies (third party collectors), state or municipal courts, and employment records. They hold a consumer's credit report in their databases. Another name for a credit bureau is a credit reporting agency.
Bureaus that collect credit information about individuals are known as consumer credit bureaus. Bureaus that collect credit information about businesses are known as commercial credit bureaus
There are three major nationwide consumer credit bureaus. They are Equifax, Experian and TransUnion. The actions of these major credit bureaus come under the FCRA which stands for Fair Credit Reporting Act.
Apart from these there are several local consumer reporting agencies like ChoicePoint, Innovis, LexisNexis and others. These have been given the term “nationwide specialty consumer reporting agency” by the FCRA. The requirements by law from the specialty agencies are different as compared to the three major credit bureaus.
How the score is computed by each bureau is a closely guarded secret. However all scores are calculated using a special algorithm. Fair Isaac Corporation was the first company to introduce credit scoring. Their score model known as the FICO score is the most common and widely used scoring system today.
Fair Isaac Corporation provides the credit bureaus with the software needed to compute credit scores from the information in the reports created by these bureaus. Hence a version of the FICO score is available at all three credit bureaus. It is named differently however.
It is called the BEACON® Score at Equifax, Experian/Fair Isaac Risk Model at Experian, and EMPIRICA® at Trans Union.
Since the reports created by credit bureaus may differ owing to differences in collection and reporting of information, the same scoring model may give different numbers at each of the three bureaus. This means that all three FICO scores will not be exactly identical.
Note: Experian has stopped selling FICO scores to consumers. What it now offers is the Plus score.
Lenders generally go by any one FICO score depending on which company they decide to purchase the score from.
Apart from FICO scores, credit bureaus also have their own scoring systems and their own scores that they use to give an indication of credit worthiness of an individual. Examples of such scoring systems are the ‘Plus’ score offered by Experian as mentioned above, Score power of Equifax and TransUnion’s TruCredit score
All the three major bureaus also provide ‘VantageScore’ which is another scoring method.
Other scoring systems available are educational scores such as TransUnion's ‘TransRisk’ or Experian's ‘ScoreX’.
Some major players in the lending game, including the major credit card issuers, have developed their own proprietary scoring models.
Different Credit Scores and their ranges
Think of the thermometer. The Fahrenheit and Celsius scale both refer to temperature. However they can be correlated to each other in a definite manner.
However in case of credit scores, to correlate one score to another in a definite, precise and reproducible manner, is not possible.
Hence it is confusing because there are too many variations and to correlate two different scoring systems is difficult.
Since lenders use FICO scores most often, it would be sensible to purchase a FICO score as a guide.
Ultimately all scores are meant to do only one thing – convey your credit bearing capacity or credit worthiness to lenders and financial institutes.
Financial lenders and institutes use the scores provided to them as a guide to lending you money.
Depending on how well you score, the interest rates and amount of credit offered to you differs.
It is extremely important that you understand that scores are dynamic entities and keep fluctuating throughout your lifetime.
What is more important than looking at your score and gloating is scanning your credit report regularly for false entries, mistakes, and disputable items, all of which could seriously harm your credit rating. Hence make it a point to be updated on your credit report from each of the three major credit bureaus.
Federal Law requires the details of credit reports created by all three major credit bureaus to be made available free to all individual members of the public every year.
The only site authorized to give these three reports is annualcreditreport.com
This means that at any one time in the year as an individual, you can be in possession of three reports, one from each major CRA.
As far as the nationwide specialty consumer reporting agencies are concerned, they are required to provide annual disclosures of their report files to any consumers who request disclosure
While the FCRA has made it mandatory to provide consumers with a free annual report by each of the credit bureaus, it is not mandatory for them to provide you with your score without a fee. Hence you need to purchase your score from them.
The contact details for the respective agencies are
FICO uses the following parameters in the following percentage breakdown to determine your credit score:
Payment History – 35%, Amounts Owed – 30%, Lengths of Credit History – 15%, New Credit – 10%, Types of Credit used – 10%
The parameters are weighed unequally, with some given more importance than others
Do you need to see your credit score?
It is a good idea to be aware of your score so you have an idea on where you stand on the credit rating scale.
The score itself is irrelevant, what matters is where this score stands when compared to the rest of the public.
According to Fair Isaac Corporation, which was the first to introduce a scoring system to establish credit worthiness, credit health amongst the Americans is broken down in the following manner.
A close evaluation of these figures will reveal to you that 58 % of the american public have scores of 700 and above, while the rest 42% lie below the 700 mark.
Since the score range in the FICO is from 300 to 850, this would give you a fair idea that the majority of people have scores above 700.
This means that a lending agency that may be considering giving credit to you will assume that you have a greater credit bearing capacity if you lie above the 700 mark and lesser credit bearing capacity if you lie below the 700 mark.
So why is credit scoring so important?
The score is like marks on a report card which you may flash about if you like but the real value of a high score is the ability of it to get you better deals and interest rates in every area that you need financial assistance or convenience for any reason.
Nobody wants to take risks on anything but a prize stallion. Lenders do not feel secure giving credit to anybody. They use the scores as well as other details on your credit report to determine whether and how much credit they should extend to you. Depending on your credit risk the rate of interest varies.
Differing interest rates mean different monthly payments for the same loan given for the same tenure, to individuals with differing credit scores.
In auto loan of $ 25,000 the interest rate difference can mean almost 12% at two ends of the spectrum. That is a lot of money.
If your scores are high it can only mean faster loans, greater credit limits, and lower interest rates.
Finance companies depend on you as much as you depend on them. It is in their best interests to separate the chaff from the grain and choose the people with whom they feel maximally secure with their money.At the same time if you have good credit habits and plan your credit wisely, it will mean higher scores and more time to enjoy life rather than worry about money and fiscal matters.
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