Credit scoring is the basis of the loan approval process from traditional lenders like banks and credit unions to online lenders like Quicken and others. It is also a major factor in how credit cards, student loans, and other forms of consumer debt are structured, paid back, and ultimately rated. Here is a quick look at how the score is calculated and what you can do to help improve your credit score.
First, you need to know what credit scores are and what is a good one. The three major credit bureaus (Expedia, Trans Union, and Equifax) calculate credit scores on a monthly basis. You may find that your credit scores are low, even if you have not had any late payments in recent months. That is because bad debts do not have an effect on the calculation, unlike good debts which are included in the calculation. So you can see why it can be confusing to understand what credit scores are.
There are two major factors that are used in calculating credit scores: the number of open accounts and the current balance owed on the accounts. Open accounts carry less weight than those with zero balances. The Fair Credit Reporting Act (FCRA) regulates how these numbers are reported to the credit bureaus and what information they can contain about you. A fair credit score is one that is based on the reports that each bureau provides you, the same reports that all consumers are entitled to free of charge. Each year, you can request a free copy of your report from each of the three bureaus for no charge.
The Fair Isaac Company and TransUnion are the two main credit scoring models. The FICO scoring models are more widely used because they are more widely used and have higher response rates. Most consumers know there are different credit scores and what is a good credit score is very relative depending on the person requesting the score. Many consumers do not understand the difference between the two scoring models and assume that all three models are equally useful.
One reason that the FICO scores are used widely is that they are a widely accepted method of measuring credit risk. Lenders have been using credit scoring to determine whether or not to make loans to people for many years now. Since the 1980s Congress has required lenders to use a numerical measure of risk when deciding whether or not to extend credit. Different companies use different approaches, but they all use a form of FICO scores. What is a good credit score for one person that may not be good for another? Because of this, even if a lender uses a different scoring model, lenders will still use the results from a FICO-based model.
The VantageScore score, which is the final result obtained from all of the other models, can provide an accurate prediction of someone’s future creditworthiness. In general, these scores are much more precise than the FICO scores used by lenders. For instance, a person with a one hundred thousand dollar credit limit who pays bills late by thirty days will have a much different score than a person with a one hundred twenty thousand dollar limit who pays his bills on time. A VantageScore score can tell a lender how likely a person is to pay his or her bills in a short amount of time. If a lender were to simply use a FICO score, he or she would make a very broad assumption about someone’s credit’s worth and would possibly make bad loans to people who just do not pay their bills on time.
This post was written by Kristian D’An, owner of Lux Credit LLC and CCA board certified credit repair specialist. Lux Credit offers credit repair services for those looking to improve their credit!
