Credit Scoring FAQ

Reproduced from www.fairisaac.com*

What is a Credit Score?
A credit score is a number lenders use to help them decide: "If I give this person a loan or credit card, will I get paid back on time?" It is one of several pieces of information that auto, mortgage, credit card and other lenders use when evaluating your application for credit.

A score is a snapshot of your credit risk picture at a particular point in time. It changes as new information is added to your credit bureau report or bank file. Only information that is proven to be predictive of future credit performance is used.

Is there just one type of credit score?
There are different types of credit scores. Credit bureau scores are based solely on information in consumer credit reports which are factual records of individuals' credit payment history. Credit reports are produced by credit bureaus from information stored in bureau databases, and are provided for a purpose permitted by law, primarily to credit grantors. Most of the information in your consumer credit report comes directly from the companies you do business with, but some information comes from public records.

Other types of credit scores may also include information from credit applications or bank files.

Who calculates credit scores?
When a lender requests your score, it is calculated by a computer at the lender or credit bureau. The score is one of many pieces of information the lender may use in evaluating your credit application.

Why do lenders use credit scores?
Credit scoring helps lenders:

• Base credit decisions on relevant credit-performance data. Credit scoring gives lenders objective and consistent assessments so they can, for example, offer applicants credit products they are likely to qualify for.
• Remove potential bias. Credit scoring's objective criteria and ease of automation help lenders comply with the letter and spirit of the law.
• Offer better terms. Credit scoring allows lenders to "price according to risk." Borrowers with an excellent credit picture may be offered lower interest rates. And riskier borrowers who might have been declined altogether in the past now have a chance to get credit.
• Control delinquencies and charge-offs. Scoring's accuracy gives lenders a reliable method of avoiding poor performing loans.
• Make more credit available. Lenders using credit scoring can expand the numbers of applications they can accept, without taking on a larger pool of poor performing loans.
• Improve operating efficiency. Credit scoring and automation speed up the entire decision process. Applicants get answers more quickly.

How are credit scores calculated?
Credit bureau scores are calculated by computer software containing a scoring model. Each model is built by analyzing the information contained in large samples of anonymous borrowers' credit files. Analysts tracked how those borrowers paid their bills and identified patterns in the credit bureau data that correlated to payment history.

Other models can be developed from different sources of data. A custom model is developed from a business's own data - information on its customers from credit application forms and credit bureau reports.

What's in a credit bureau score?
Credit bureau scores are based on five main categories of credit information. These are, in order from most to least important:

1. Late Payments, Delinquencies, Bankruptcies
2. Outstanding Debt
3. Length Of Credit History
4. New Applications For Credit (Inquiries)
5. Types of Credit in Use

Late payments, delinquencies and bankruptcies are important factors in bank lending decisions. People who always pay their bills on time create a reliable track record that the bank can be comfortable with. On the other hand, banks are more reluctant to lend to someone who consistently pays late.

Similarly, the amount of debt you have will help a bank determine if it should issue you a loan. People who have taken out a significant number of loans and who already owe a great deal are a greater risk for banks.

Your credit snapshot will improve over time if you make changes now in the way you handle credit. Make sure the information in your credit report is correct, too.

Lastly, someone who goes on a credit shopping "binge," by attempting to sign up for many different credit lines at the same time, raises serious questions for lenders. Responsible use of credit makes it more likely that you will be approved for new loans in the future.

What's not in a credit bureau score?
U.S. law is very specific about what cannot go into a credit score. The following information is prohibited:

• Ethnic Group
• Religion
• Sex
• Marital Status
• Nationality

What's the most important factor in scoring?
Scores are based on a person's whole credit picture. No one factor determines a score. A credit score is a composite of both positive and negative information such as missed payments or bankruptcies (if any) as well as accounts paid satisfactorily. That said, several areas of the credit bureau report carry the most weight in a credit score.

Past Payment Performance. The fewer late payments, the better the score. However, if there are late payments, those that are most recent are more indicative of future default than those that occurred in the past. Naturally, having no late payments is best.

Credit Use. People who are heavily extended tend to be higher risks than those who use credit conservatively. For example, someone using 75% of his or her available credit represents greater risk than someone who is using only 25%.

Credit History. The longer someone has had credit established, the better. For example, a borrower who has had credit for less than two years represents a relatively higher risk than someone who has had credit for five years or more. But, having a relatively brief credit history does not automatically mean higher risk. What carries the most weight is how people pay their bills and how extended they are on their available credit.

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About Your Credit Score

What is a good score to get?
A "good" score is a number that matches the level of risk a lender is willing to accept for a particular loan or credit card. For example, one score may qualify you for a gold credit card, whereas another score may indicate you're a better match for a standard card. Scoring systems have varying numeric scales.

Scores are dynamic and change when new information is added to the credit file. Also, lenders use different types of scores with varying numeric scales. In addition, other factors, like application information, impact lenders' credit decisions. Remember, what's considered an acceptable score varies from lender to lender depending on the loan or credit card applied for.

How can I improve my credit score?
Scores reflect credit payment patterns over time with more emphasis on recent information. To improve a score:

• Pay your bills on time. Delinquent payments and collections can have a major negative impact on a score.
• Keep balances low on unsecured revolving debt like credit cards. High outstanding debt can affect a score.
• Apply for and open new credit accounts only as needed. The amount of your unused credit is an important factor in calculating your score.
• Make sure the information in your credit report is correct, too. If you find errors, contact the credit bureau and your lender.
• Don't try to quickly maneuver your score. It can backfire and actually hurt your score if you suddenly close several or all credit card accounts, for example. Or if you try to spread a large balance across multiple cards rather than leave it on an existing single card.

What if the information in my credit report is wrong?
You should make sure the information in your credit report is correct. Review your credit report from each credit bureau at least once a year and especially before making a large purchase, like a house or car. Contact these credit bureaus to request a copy:

EQUIFAX (800) 685-1111
EXPERIAN (800) 422-4879
TRANS UNION (800) 888-4213

If you find an error, the bureau must investigate and respond to you within 30 days. If you are in the process of applying for a loan, immediately notify your lender of any incorrect information in your report. Small errors may have little or no effect on your score. If there are significant errors, however, the lender may disregard the score.

Once my credit report is updated, how long before my score is updated?
All updates or changes made to your credit file are immediately considered in your next credit score. That's because your Fair, Isaac credit bureau score is calculated at the same time that the lender gets your credit report from a credit bureau. This is why your score is really a snapshot of your credit risk picture at a particular point in time.

Are the Fair Isaac credit bureau risk scores provided by all three major U.S. credit bureaus?
Yes, credit bureau risk scores developed by Fair, Isaac are provided by all three major U.S. credit bureaus. They are called BEACON at Equifax, EMPIRICA at Trans Union and The Experian/ Fair, Isaac Model at Experian.

How about the two major Canadian credit bureaus?
Yes, credit bureau risk scores developed by Fair, Isaac are provided by the two major Canadian credit bureaus. They are called BEACON at Equifax Canada and EMPIRICA at Trans Union Canada. Experian does not have a Canadian credit bureau.

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About Inquires for Your Credit Report

What is an inquiry on my credit report?
An inquiry is a notation on your credit report that shows that a lender asked to view your report. It says who asked for the copy, when they received it, and (if you ask the credit bureau) their address.

Can inquiries affect my score?
Careful study has shown that inquiries are an indicator of credit risk. The more inquiries that appear on a borrower's credit file, the more likely a borrower may be to not pay his or her bills as agreed. However, inquiries have a relatively small impact on your credit score. In a credit scoring model there are other, stronger indicators of future payment performance, such as past payment history and use of credit, that can offset this one bit of information.

Does every inquiry affect my score?
No. Inquiries fall into two categories: inquiries that you initiate and inquiries initiated by others. Fair, Isaac risk scoring software only considers inquiries initiated by you for business purposes. Examples of this type of inquiry include mortgage applications, credit card applications and auto loan applications.

Inquiries initiated by others - which are not considered in a score - include employment inquiries, promotional inquiries and account management inquiries. Promotional inquiries are those made by lenders who wish to make you an offer of credit which you did not request. Account management inquiries are those made by companies with which you already have credit.

Finally, you can call any of the major credit bureaus (Equifax, Experian, and Trans Union) and request a copy of your credit report. This is called a "consumer disclosure" inquiry but it is not considered when calculating your score.

Will I be penalized for shopping around for the best interest rate?
Fair, Isaac's risk scoring software takes the appropriate steps to make sure your score is not lowered because of the multiple inquiries that might occur as a result of shopping for the best terms in an auto or home loan.

Here's how it works. Fair, Isaac risk scoring software ignores all auto- or mortgage-related inquiries that occur in the 30-day period (called the "buffer" period) prior to the day your credit score is calculated. And prior to that buffer period, the software also notes when earlier inquiries were made - if any - and counts bodytext 14 days from each one. In any 14-day segment, the software then counts all auto- or mortgage-related inquires as just one inquiry.

An example might help. Let's say John Doe is shopping for a mortgage loan and a lender gets his credit report on November 30. John's credit report also lists two or three other mortgage inquiries that were made earlier that month. The Fair, Isaac risk scoring software ignores those previous mortgage inquiries when calculating John's credit score because they all fell into the 30-day buffer period.

Now let's say that John also purchased a car three months before he began shopping for a mortgage loan. His car shopping resulted in three inquiries from different banks and credit unions over several days. Since they occurred in the same 14-day period, those three inquiries are counted as just one inquiry by the Fair, Isaac risk scoring software.

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About Lender Decisions

Who...or what...decides if I get my loan?
Loan officers decide. Computers and credit scoring are tools they may use to help make the decision. They may use computers to crunch numbers, automatically obtain credit bureau reports, and generate customer communications. If a lender uses credit scoring, the computer will either calculate the applicant's score with its own internal scoring model, or automatically obtain a score from the credit bureau. Lenders vary in how they interpret this data and how they weigh it against other important information such as income, time at employer, the net value of liquid assets, and value of collateral, if any.

In mortgage lending, both Freddie Mac and Fannie Mae - the two main government-chartered companies that purchase billions of dollars of newly originated home loans annually - agree that lenders should focus both on the score and on other outside factors when making a decision.

Has credit scoring speeded up loan decisions?
Scoring has helped lenders process credit applications and make loan decisions faster. For example, without credit scoring lenders take an average of 12 hours to decide whether to give credit to a small business. This can be cut to as little as 15 minutes using credit scoring and automated processing software. For consumers, auto lenders using credit scoring can deliver a decision within an hour on nearly 60% of auto loan applications, as show below:

36% Half an hour to one hour
23% Under half an hour
31% One to two hours
10% More than two hours

Source: Consumers Bankers Association

What if I'm turned down for credit?
While lenders are not required to disclose a score, if you have been turned down for credit, the Equal Credit Opportunity Act (ECOA) requires that you be given the reasons why within 30 days. Possible reasons a score is too low might include recent late payments or too much outstanding credit. You are also entitled to a free copy of your credit bureau report within 60 days of being declined for credit.

How can I makes sure my credit information is accurate?
Since credit bureau scores are based upon information in your credit bureau reports, you should check your reports from each of the three bureaus to make sure your credit information is accurate. If you are considering applying for a large loan for a car or house, check your credit bureau reports before you start looking. Correcting any problems early will help make your loan application process simpler and easier.

There are three main credit bureaus in the U.S. Each may have slightly different information in your file, so be sure to request a copy of your credit report from each. If you've been turned down for credit, the issuing credit bureau is required by law to provide you with your report for free. Carefully review the report to verify that all of the information is correct. If you find any mistakes, report them to the bureau immediately. By law, the bureau must respond to your inquiry within 30 days.

You can reach the bureau at the following phone numbers:
EQUIFAX: (800) 685-1111
EXPERIAN: (800) 422-4879
TRANS UNION: (800) 888-4213

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*Reprinted with permission of Fair, Issac and Co., copyright 2001. For more information visit www.fairisaac.com

Next: Maintaining Your Credit