Ever wonder how a creditor decides whether to grant you credit? For
years, creditors have been using credit scoring systems to determine
if you'd be a good risk for credit cards and auto loans. More recently,
credit scoring has been used to help creditors evaluate your ability
to repay home mortgage loans. Here's how credit scoring works in
helping decide who gets credit -and why.
What is credit scoring?
Credit scoring is a system creditors use to help determine
whether to give you credit.
Information about you and your credit experiences, such as
your bill-paying history, the number and type of accounts you
have, late payments, collection actions, outstanding debt,
and the age of your accounts, is collected from your credit
application and your credit report. Using a statistical program,
creditors compare this information to the credit performance
of consumers with similar profiles. A credit scoring system
awards points for each factor that helps predict who is most
likely to repay a debt. A total number of points -- a credit
score -- helps predict how creditworthy you are, that is, how
likely it is that you will repay a loan and make the payments
when due.
Because your credit report is an important part of many credit
scoring systems, it is very important to make sure it's accurate
before you submit a credit application. To get copies of your
report, contact the three major credit reporting agencies:
Equifax
Experian
Trans
Union
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Why is credit scoring used?
Credit scoring is based on real data and statistics, so it
usually is more reliable than subjective or judgmental methods.
It treats all applicants objectively. Judgmental methods typically
rely on criteria that are not systematically tested and can
vary when applied by different individuals.
How is a credit scoring model developed?
To develop a model, a creditor selects a random sample of its
customers, or a sample of similar customers if their sample
is not large enough, and analyzes it statistically to identify
characteristics that relate to creditworthiness. Then, each
of these factors is assigned a weight based on how strong
a predictor it is of who would be a good credit risk. Each
creditor may use its own credit scoring model, different scoring
models for different types of credit, or a generic model developed
by a credit scoring company.
Under the Equal Credit Opportunity Act, a credit scoring
system may not use certain characteristics like -- race, sex,
marital status, national origin, or religion -- as factors.
However, creditors are allowed to use age in properly designed
scoring systems. But any scoring system that includes age must
give equal treatment to elderly applicants.
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What can I do to improve my score?
Credit scoring models are complex and often vary among creditors
and for different types of credit. If one factor changes,
your score may change -- but improvement generally depends
on how that factor relates to other factors considered by
the model. Only the creditor can explain what might improve
your score under the particular model used to evaluate your
credit application.
Nevertheless, scoring models generally evaluate the following
types of information in your credit report:
Have you paid your bills on time? Payment history typically
is a significant factor. It is likely that your score will
be affected negatively if you have paid bills late, had an
account referred to collections, or declared bankruptcy, if
that history is reflected on your credit report.
What is your outstanding debt? Many scoring models evaluate
the amount of debt you have compared to your credit limits.
If the amount you owe is close to your credit limit, that is
likely to have a negative effect on your score.
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How long is your credit history?
Generally, models consider
the length of your credit track record. An insufficient credit
history may have an effect on your score, but that can be offset
by other factors, such as timely payments and low balances.
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Have you applied for new credit recently?
Many scoring models
consider whether you have applied for credit recently by looking
at "inquiries" on your credit report when you apply
for credit. If you have applied for too many new accounts recently,
that may negatively affect your score. However, not all inquiries
are counted. Inquiries by creditors who are monitoring your
account or looking at credit reports to make "prescreened" credit
offers are not counted.
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How many and what types of credit accounts
do you have?
Although
it is generally good to have established credit accounts, too
many credit card accounts may have a negative effect on your
score. In addition, many models consider the type of credit
accounts you have. For example, under some scoring models,
loans from finance companies may negatively affect your credit
score.
Scoring models may be based on more than just information
in your credit report. For example, the model may consider
information from your credit application as well: your job
or occupation, length of employment, or whether you own a home.
To improve your credit score under most models, concentrate
on paying your bills on time, paying down outstanding balances,
and not taking on new debt. It's likely to take some time to
improve your score significantly.
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How reliable is the credit scoring system?
Credit scoring systems enable creditors to evaluate millions
of applicants consistently and impartially on many different
characteristics. But to be statistically valid, credit scoring
systems must be based on a big enough sample. Remember that
these systems generally vary from creditor to creditor.
Although you may think such a system is arbitrary or impersonal,
it can help make decisions faster, more accurately, and more
impartially than individuals when it is properly designed.
And many creditors design their systems so that in marginal
cases, applicants whose scores are not high enough to pass
easily or are low enough to fail absolutely are referred to
a credit manager who decides whether the company or lender
will extend credit. This may allow for discussion and negotiation
between the credit manager and the consumer.
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What happens if you are denied credit or don't get the terms
you want?
If you are denied credit, the Equal Credit Opportunity Act
requires that the creditor give you a notice that tells you
the specific reasons your application was rejected or the fact
that you have the right to learn the reasons if you ask within
60 days. Indefinite and vague reasons for denial are illegal,
so ask the creditor to be specific. Acceptable reasons include: "Your
income was low" or "You haven't been employed long
enough." Unacceptable reasons include: "You didn't
meet our minimum standards" or "You didn't receive
enough points on our credit scoring system."
If a creditor says you were denied credit because you are
too near your credit limits on your charge cards or you have
too many credit card accounts, you may want to reapply after
paying down your balances or closing some accounts. Credit
scoring systems consider updated information and change over
time.
Sometimes you can be denied credit because of information
from a credit report. If so, the Fair Credit Reporting Act
requires the creditor to give you the name, address and phone
number of the credit reporting agency that supplied the information.
You should contact that agency to find out what your report
said. This information is free if you request it within 60
days of being turned down for credit. The credit reporting
agency can tell you what's in your report, but only the creditor
can tell you why your application was denied.
If you've been denied credit, or didn't get the rate or credit
terms you want, ask the creditor if a credit scoring system
was used. If so, ask what characteristics or factors were used
in that system, and the best ways to improve your application.
If you get credit, ask the creditor whether you are getting
the best rate and terms available and, if not, why. If you
are not offered the best rate available because of inaccuracies
in your credit report, be sure to dispute the inaccurate information
in your credit report.
Where can you get more information? Call 954-483-8065.
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