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Credit scoring predicts
borrower behavior
Until recently, bad credit was something of a mystery. That’s
because there was no uniform, statistical way of measuring
people’s credit behavior. A few years ago, however, a company
called Fair Isaac Corporation developed a uniform credit scoring
method called the FICO score. Because each of the major credit
bureaus (Experian, Equifax, and TransUnion) have different
information about you, your FICO score established by each of
these companies will differ somewhat. You FICO score is one of
the best indicators of how good or bad your credit is. To come
up with your score, the information in your credit report is
compared mathematically to the credit report information of
millions of others. Your future credit behavior can more easily
be predicted based on this data. Most lenders use the FICO score
as a starting point when deciding whether or not to extend
credit to you.
Low scores: the good news
Having a lower FICO score doesn’t mean you won’t be able to
borrow money. In the past, before credit scoring became
standardized, many lenders were hesitant to take any risks at
all. They were not good at predicting who would default on a
loan and who would not. They would see one negative item on a
credit report and simply refuse to extend any credit at all to
some individuals. Today, however, even borrowers who have
problems in their credit history have access to credit.
Standardized credit scores and statistical models allow lenders
to predict borrower behavior more accurately. As a result, many
companies now offer a wide variety of credit programs tailored
to individuals of varying risk levels. High-risk borrowers who
may not have qualified for credit in the past are now more
likely to do so. Lenders usually charge those individuals higher
interest rates.
Credit scores: the good, the bad, and the average
FICO credit scores range from a low of 300 to a high of 850. The
higher your score, the better. According to Experian, one of the
three major credit reporting bureaus, the average American
credit score is 677. Fair Isaac suggests that to qualify for the
most favorable lending terms, including the lowest interest
rates, you need a score of 720 or higher. The three major credit
bureaus, as well as the Fair Isaac Corp. and other companies,
will make your credit score available to you for a fee.
The most important factor: your payment history
Many factors go into determining your credit score, but some
factors are weighed more heavily than others. The most important
factor is your payment history, which accounts for approximately
35% of your credit score. Payment history includes payment
information on credit cards, mortgages, auto loans, and other
loans. Missing payments or making late payments will affect your
credit score negatively. Bankruptcy or other financial judgments
against you also have a negative impact on your score.
Other factors affecting your credit score
The amount of money you owe, how much credit you have available
to you, and the proportion of credit balance to total credit
limit all affect your credit score. The length of your credit
history is also important. Having a long, good credit history is
obviously better than having a short credit history. Also taken
into account is recent credit activity (such as applying for a
new credit card) and the type of credit you have used in the
past (credit cards, installment loans, consumer finance loans,
etc.)
What to do if your credit score is low
Your credit score is not the only criteria a lender looks at
when deciding whether or not to give you credit, but it is a
major factor. Most lenders also look at your credit report,
which gives details about your credit behavior. If you can show
that your most recent payment history is good, despite past
credit problems, many lenders will give you credit. Making a
sincere effort to manage your credit responsibly will help to
raise your credit score over time. Lenders each have their own
guidelines and criteria for granting credit. In some
communities, it pays to get to know your local lenders
personally. Once they get to know you, they may feel more
comfortable giving you credit even though your score is not as
high as they would like.
The bottom line? Just because you are turned down for credit by
one lender doesn’t mean they all will. Some credit companies
specialize in working with people who have past credit problems.
It pays to shop around.
TIP: Do not be fooled by companies claiming to raise your credit
score over a few days. You must be patient and persistent if you
wish to improve bad credit.