Let’s Talk About Credit Scores

House model

What are credit scores and what is its role in the financing process? This article discusses the fundamentals of the whole credit scoring system.

One of the most vital parts of the lending process is a borrower’s credit score. This is the three-digit number that lenders use to decide a borrower’s risk.

This is used widely in the financing industry and can affect whether or not you qualify for a credit card or a loan.

If you are planning to get financing in the near future and have not established credit yet, this article will guide you to the basics of a credit score.

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How are credit scores created?

A credit score is built on your credit history. That is your record of debts and payments over a period of time.

This record is compiled and assessed by the country’s three credit reporting bureaus or agencies: Equifax, TransUnion, and Experian.

They then create your credit scores using credit scoring models provided by FICO and VantageScore. The agencies may however make their own calculations of your score based on their own proprietary models. This results to multiple credit scores so don’t be surprised if your score from TransUnion differs from that given by Experian.

How do lenders categorize scores?

Though the credit agencies make use of VantageScore model for uniformity purposes, most lenders use the FICO score as scale.

The following lays down the differences between the two models.

VantageScore FICO
Most Popular Model VantageScore 3.0 FICO Score 8
Score Range 300 to 850 300 to 850
Scoreable Population 225 million 190 million
Share of Lenders Using Score 80% of the 25 largest lenders 90% of the 100 largest lenders
Scores Issued per Year 8 billion 10 billion
Recent Credit Experience Needed for Score 1 month 6 months
Inquiry Grouping Period* 14 days 30-45 days
Late-Payment Damage Missed mortgage payments are more damaging than other types Late payments are treated equally, regardless of account type
Treatment of Collection Accounts Once paid, collection accounts stop being considered Collection accounts with original balances under $100 aren’t considered
Authorized Users Moderate credit-building capacity Limited credit-building capacity

Source: WalletHub

Both scoring models adopted the 300 to 850 scoring range where:

  • Scores below 600 are usually categorized as high risk
  • Scores above 700 are usually categorized as low risk

What are the types of credit scores?

Generic credit score – used by various lenders and entities in determining an individual’s credit risk. It makes use of a similar formula across the three agencies

Custom credit scores – unique to specific businesses and is generated using records from the lender’s own portfolio; its use is only for individual lenders

What factors influence a borrower’s credit score?

Your credit card payments aren’t the only determining factor that creates your credit score. There are multiple elements that can skew your score to both ends of the scale.

These factors include: a) your total debt, b) the types of accounts you hold, c) the age of these accounts, and d) if you have late payments.

A combination of these factors give you the score that is computed by each of the agencies.

If your lender does not make reports to all of the three credit bureaus, this may result to differences in your scores. The variation in the scoring model used may also contribute to differences in scores.

How do I improve my credit score?

Practicing responsible credit habits can help you keep your credit score up. Along with personal discipline, achieving a prime or excellent score is not impossible if you:

  • paying your bills on time
  • keeping your overall debt at a reasonable level relative to your income
  • actively and responsibly using several credit cards

On the other hand, the following will most likely land you a bad spot on any scoring model’s scale:

  • consistently paying your bills late
  • declaring bankruptcy
  • owing a large amount of non-mortgage debt
  • carrying a large number of credit cards
  • applying for multiple credit cards or loans within a recent time period

Every borrower is entitled to a free copy of their credit report at least once in a year. Please go to annualcreditreport.com to ask for your own rating and assess your report.

Make sure there are no errors in your report. If in case you find any, you are encouraged to report the error to the agency and your creditor. The report should tell you how to file a dispute.

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