credit scores work, how a score is calculated|
Pat Curry Bankrate.com||
why you can go online and be approved for credit within 60 seconds? Or get pre-qualified
for a car without anyone even asking you how much money you make? Or why you get
one interest rate on loans, while your neighbor gets another?
The answer is credit scoring.
credit score is a number generated by a mathematical algorithm -- a formula --
based on information in your credit report, compared to information on tens of
millions of other people. The resulting number is a highly accurate prediction
of how likely you are to pay your bills.
If it sounds arcane
and unimportant, you couldn't be more wrong. Credit scores are used extensively,
and if you've gotten a mortgage, a car loan, a credit card or auto insurance,
the rate you received was directly related to your credit score. The higher the
number, the better you look to lenders. People with the highest scores get the
lowest interest rates.
Lenders can use one of many different credit-scoring models to determine
if you are creditworthy. Different models can produce different
scores. However, lenders use some scoring models more than others.
The FICO score is one such popular scoring method.
Its scale runs from 300 to 850. The vast majority
of people will have scores between 600 and 800. A score of 720 or
higher will get you the most favorable interest rates on a mortgage,
according to data from Fair Isaac Corp., a California-based company
that developed the first credit score as well as the FICO score.
Isaac reports that the American public's credit scores break out along these lines:
Currently, each of the three major credit bureaus
uses their own version of the FICO scoring method -- Equifax has
the BEACON score, Experian has the Experian/Fair Isaac Risk Model
and TransUnion has the EMPIRICA score. The three versions can come
up with varying scores because they use different algorithms. (Variance
can also occur because of differences in data contained in different
That could change, depending on whether a new credit-scoring
model catches on. It's called the VantageScore.
Equifax, Experian and TransUnion collaborated on its development
and will all use the same algorithm to compute the score. Consumers
can order their VantageScores online at Experian's Web
site for $6. Its scoring range runs from 501 to 990 with a corresponding
letter grade from A to F. So, a score of 501 to 600 would receive
an F, while a score of 901 to 990 would receive an A. Just like
in school, A is the best grade you can get.
What's the big deal?
No matter which scoring model lenders use, it pays to have a great
credit score. Your credit score affects whether you get credit or
not, and how high your interest rate will be. A better score can
lower your interest rate.
The difference in the interest rates
offered to a person with a score of 520 and a person with a 720 score is 4.36
percentage points, according to Fair
Isaac's Web site. On a $100,000, 30-year mortgage, that difference would cost
more than $110,325 extra in interest charges, according to Bankrate.com's mortgage
calculator. The difference in the monthly payment alone would be about $307.
If you rented an apartment, got braces, bought cell phone
service, applied for a job that involved handling a lot of money, or needed to
get utilities connected, there's a good chance your score was pulled.
you have an existing credit card, the issuer is likely to look at your credit
score to decide whether to increase your credit line -- or charge you a higher
interest rate, according to a credit scoring study by the Consumer Federation
of America and the National Credit Reporting Association.