Credit Scores

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Lenders review a variety of information to help them decide whether or not a consumer loan applicant represents an acceptable level of risk. In this process, they will review one or more of the consumer's credit scores. A credit score is typically a three-digit number that tells a lender how likely an individual is to repay a loan and if their payments will be made on time. The score is derived by using a mathematical equation that evaluates the information contained in the consumer's credit report.

There are two primary types of credit scores, FICO and Vantage. The more popular of the two scoring methods is the risk evaluation system created by the Fair Isaac Company, commonly referred to as a FICO score. There are five major elements that are factored into the FICO scoring formula.

The Five Components of the FICO Scoring System

Payment History: 35% of Score

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This is the greatest single factor within your credit score. It is natural for a lender to want to know how a consumer has managed their financial obligations in the past. Late payments are not a complete negative, but they should be avoided at all costs. If the other elements of your score are in good shape, you can overcome one or two instances of late payments, but you must keep these to an absolute minimum.

Your payment history takes into account your payments on a wide variety of loans, including Visa, MasterCard, American Express and retail store credit cards, installment loans, finance company and mortgage accounts. It also includes any bankruptcies, monetary judgments, lawsuits, wage garnishments, and collection actions that have been taken against you. These are considered serious; however, older items count less than recent items.

It is also important to realize that the absence of late payments altogether does not guarantee automatic approval, either. The remaining four components also factor into your score.

Amounts Currently Owed: 30% of Score

Many consumers carry balances on their credit cards, car loans, mortgages, and other types of accounts. Owing a significant amount can be an indication that the consumer is overextended, which may lead to their making late payments or no payments at all. This factor attempts to predict whether the consumer can currently manage more credit responsibly.

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Length of Credit History: 15% of Score

This factor considers the age of the consumer's oldest credit account and the average age of all their accounts. A longer, positive, credit history will increase a score. An individual with a brief credit history may still earn a high credit score if the other components are in good shape.

New Credit: 10% of Score

Opening several new accounts or making a number of applications for credit in a relatively short period of time can negatively affect your score. The FICO system recognizes the difference between a consumer attempting to open several new lines of credit from one who is simply shopping around for the lowest rates. It is fairly easy to avoid losing points in this factor. If, for example, you are planning a major purchase, such as an automobile, it's best to do your research on the vehicles that interest you in advance, and confining your dealer-to-dealer search to a period of less than two weeks. This way, you can avoid the multiple credit inquiries that lower your score.

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The Types of Credit Used: 10% of Score

This component takes into consideration the consumer's entire portfolio of credit cards, loans, finance accounts, and mortgages. Consumers who deal exclusively with sub-prime or "D" lenders are considered a higher risk, even if their payment history is perfect. This factor does not usually play a big part in the lender's decision to extend credit; however, if there is not a lot of other information to go on, this element will take on greater weight.

Each of these factors is considered in the calculation of the consumer's credit score; no single element will determine the score. Depending on the information in your credit report, one factor can play a decisive role in the overall score, regardless of the percentage the particular factor contributes. When a lender receives a credit score, they will also receive up to four "score reason codes." If the score was low, these codes explain the reasons why.

What is "Good" or "Bad" Credit?

While each creditor uses its own criteria to access credit risk, the following list illustrates the general ranges of credit scores and the grades assigned to each.

  • 720 and above: A+ Credit
  • 700 - 719: A Credit
  • 675 - 699: A- Credit
  • 620 - 674: B Credit
  • 560 - 619: C Credit
  • 500 - 559: C- Credit
  • 499 and below: D Credit
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675 and Above

In general, a score of 675 or above indicates a very good credit history. An individual with a score in this range has a greater chance of obtaining loans at relatively low interest rates.

620 to 674

Scores between 620 and 679 generally indicate good credit. An individual with a score in this range has a good chance of securing loans at competitive rates, but may have to provide additional documentation and/or explanations about information on their credit report before approval is granted.

560 to 619

A score in this range prevents an individual from getting the best interest rates. They would very likely have to provide additional documentation and explanations to the lender about information on their credit report before their loan would be approved.

559 and below

Those individuals with scores of 559 and below may be prevented from obtaining financing, because they are generally considered a significant credit risk. If they do qualify, they will incur the highest interest rate charges.

Credit Score Example

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The following examples illustrate the relationship between credit scores, interest rates and monthly mortgage payments. Each of these ordinary consumers has a $200,000.00 mortgage. Each also has a unique credit score. Note how their score affects their payments, both monthly and over the full term of the loan.

  • 720 and above
  • Interest Rate: 5.859%
  • Monthly Payment: $1,181.00
  • Interest: $225,171.00
  • Total Mortgage Amount: $425,171.00
  •  
  • 700 - 719
  • Interest Rate: 5.984%
  • Monthly Payment: $1,197.00
  • Interest: $230,936.00
  • Total Mortgage Amount: $430,936.00
  •  
  • 675 - 699
  • Interest Rate: 6.521%
  • Monthly Payment: $1,267.00
  • Interest: $256,084.00
  • Total Mortgage Amount: $456,084.00
  •  
  • 620 - 674
  • Interest Rate: 7.671%
  • Monthly Payment: $1,422.00
  • Interest: $311,892.00
  • Total Mortgage Amount: $511,892.00
  •  
  • 560 - 619
  • Interest Rate: 8.531%
  • Monthly Payment: $1,542.00
  • Interest: $355,200.00
  • Total Mortgage Amount: $555,200.00
  •  
  • 500 - 559
  • Interest Rate: 9.2879%
  • Monthly Payment: $1,651.00
  • Interest: $394,362.00
  • Total Mortgage Amount: $594,362.00

The Vantage Score

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In early 2006, the three major credit bureaus, Experian, Equifax and Trans Union, introduced a new scoring model, the Vantage scoring system. In the past, each bureau produced a score that was based solely on the information that had been reported to them, and each had a unique formula for interpreting that data. Unfortunately, few creditors report to all three bureaus, thus, the three scores could vary widely from one bureau to the next. The Vantage scoring model should reduce those variations, since it will employ the same formula to the bureaus' information. The scores, which range from 501 to 990, should be easier for consumers to interpret, since the grading system is similar to those used in schools. The Vantage credit ratings are shown below.

  • 901 - 990 = "A" credit
  • 801 - 900 = B
  • 701 - 800 = C
  • 601 - 700 = D
  • 501 - 600 = F

At this writing, details about the components and weighting rationale of the Vantage system have not been released.