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Credit Scoring Basics
Michael Killian
What is a credit score? Is
there a good or bad side to credit scoring? How is a score calculated?
What is "FICO"? What are the benefits of credit scoring? What are the
down sides?
In a nut shell, a high credit score helps your request for credit to be
approved. It can also mean lower interest on loans or even insurance
rates. Low credit scores can cause higher rates and loan denials... and
even that promotion or new job you were seeking.
How Is A Credit Score Calculated?
The credit granting agency utilizes a computer software designed by
folks such as Fair, Isaac. An acceptable point value is established
based upon selected criteria which offers the lender insight as to the
risk involved with getting the loan.
The loan applicant gives information to the lender which is submitted to
a credit bureau. Per Fair, Isaac, the credit bureau then returns a:
"credit bureau risk score, commonly known as a FICO score, [which] is a
snapshot of your credit risk picture at a particular point in time."
Lenders can then determine, 'If I give this person a loan or credit
card, will I get paid back on time?'"
Is Credit Scoring Objectivity Questionable?
Fair, Isaac concludes: "Computers don't make lending decisions, lenders
do. Computers analyze credit information to produce a score, but
individual lenders decide what scores are acceptable for different loans
or credit cards. "
The problem is that subjectivity has been completely removed in the
models. Models should make recommendations not decisions and that is
usually not the case today... it is more "expeditious" and "efficient"
to rely on the model. The model, then, has become the decision instead
of the guide.
What's the Benefit to Credit Scoring?
Consider, what would happen without a model system? In many cases the
result would be non standard chaos based upon subjective guesswork and
prejudicial criteria. If I am a bald lender and very sensitive to long
hair, isn't it possible without a measuring standard to be prejudicial
in my decision to loan out my money to a long haired rock musician?
Now add on something a little closer to reality like race, color, creed,
etc. None of these should be permitted into the decision making process.
But we all know of incidents with objective measures fully in place
where it has still happened. How bad would it be without a system, any
system, fully in place?
On the other hand, what would happen if very few applications were
turned down? There is no standard so how am I, the lender, suppose to
know who will and will not pay me back. I can't predict the future. The
very reputable and honest person in front of me may well have
extraordinary events occur tomorrow. Without some measure of prediction,
I could loose more loans then are paid back. That's a tough way to stay
in business and not to very welcome at the next meeting of the
stockholders.
What Is a "FICO Score" and How Is It Calculated
Information about you is collected from your credit application and
other sources. Data includes your bill-paying history, the number and
type of accounts you have, late payments, collection actions,
outstanding debt, age of your accounts, and other information. Using the
Fair, Isaac statistical program or model, creditors compare this
information to the credit performance of consumers with similar profiles
and award points for each factor that helps predict who is most likely
to repay a debt. Thus comes the term "FICO Score" which means, a credit
score based on the Fair, Isaac Company (FICO) model.
Credit information is weighted based upon its type and history... the
more current the good or bad information, the more weighty the affect.
For example a very old 90 day late may be less weighted than a very
recent 30 day late. The type of data is also weighted:
Past Payment Performance (35% or at least heaviest weight)
Credit Utilization (30% or next heaviest)
Credit History (15% or third weight)
Types of Credit In Use (10% or least weighted)
Inquiries (10% or least weighted).
You will find greater detail of the above data in the follow up article,
Improving Your Credit Score.
What's a Good Score?
FICO scores can impact the interest you pay on a loan, how much you pay
for insurance and a myriad of other decisions. It should also be noted
that general US population FICO Scores range
780 to 850 - 20%
740 to 780 - 20%
690 to 740 - 20%
620 to 690 - 20%
Below 620 - 20%
How Can I Get My Score
Though credit REPORTS can be obtained for free as shown in the article
referenced below, a credit SCORE will have an associated cost but can be
obtained from the same source from which you get a credit report. You
will find all of this information in the article Free Credit Report.
Article Directory:
www.articledashboard.com
Mike has been an
Internet Guide/Writer in the field of Credit/Debt Management for over 10
years. His site was awarded Best Of Net by Forbes Publication from 2000
to 2005 with site visitation doubling to over 500,000 average views per
month in the last year. He has also offered debt elimination seminars to
businesses and community colleges for the last 9 years. He has been
interviewed on the radio many times and referenced in numerous
publications.
learncreditmanagement.com/
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The Credit Road Map
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