Credit Scores

It's all in the numbers. A good credit score can open doors to better loans and insurance rates.

Here's what you need to know about these all-important ratings.

What is a credit score?

A credit score is a mathematical algorithm used to predict risk. The formula compares factors associated with accounts that have been paid on time against those that have not been paid on time, to see what factors each type of consumer has in common. The number that comes out of this analysis is used in different ways to predict risk to the lender or company requesting the score.

Lenders use a credit score to help them make credit-granting decisions. Insurance companies use insurance scores to help them evaluate new and renewal insurance requests. Some employers use consumer scores to help them make hiring decisions.

There are different types of scores, though many are developed by the Fair, Isaac and Company, Inc. These are commonly referred to as FICO scores. Your credit score can be different depending on the formula used by the lender or credit bureau that calculates it, and it can change over time. Even a FICO-based score will be different depending on why or how it was prepared.

Your credit score is not permanent and it changes from day to day, from industry to industry, and differs from one credit bureau (or lender) to another. In addition, credit scoring systems evaluate all of the information on your credit report, whether the information is accurate or not. If there are errors on your credit reports you could wind up paying a higher interest rate for a loan or a credit card than what should be available to you because of these errors. In addition, there are common misconceptions about credit that may cause you to inadvertently hurt your score, and cost you money.

What you should know about credit scoring !

Credit scores may not be available on your consumer credit report. A credit score is not currently available to you on your standard consumer credit report, unless you live in California or you order your credit report from Trans Union and request one.

If you order your credit report online, however, there are companies who will add your credit score along with your credit report. The fee for this report plus score could be $25 or more.

What does the number indicate? From our perspective, knowing your credit score is only partially useful.

Sure, it may be comforting to know that you are 712 out of a possible 900, or that you have improved from a 585 to a 630. But much more important is knowing how to achieve the best score regardless of the method used. If you are a 585 now, and you remove incorrect information that is having a negative affect on your credit, your credit will improve and the offers you get will be relatively better as well. Remember that the goal is gaining control and saving money, not just raising or changing a numerical score.

A consumer has many credit scores. Credit scores come from many sources. Companies build custom credit scoring models for different industries including credit cards, real estate financing, and insurance.

Your credit score differs depending on what type of credit you are seeking and to whom you apply.

Though many lenders incorporate FICO scores into their decision-making process, there is no single acceptable score used by all lenders, rather it varies between industries and credit type. It is important to note that your score will be different, depending on the source -- different credit bureaus, different lenders, etc. It's worth repeating: you do not have a single credit score!

Types of Credit Scores

Below is a list and brief description of some of the different types of consumer scores.

Insurance bureau score: An insurance rating based solely on credit bureau data stored at the major credit bureaus. It offers a snapshot of an individual's insurance risk at a particular point in time, and helps insurers evaluate new and renewal auto and homeowner insurance policies. It may also influence the rate you are offered.

Application score: The use of a statistical model to objectively evaluate and assign a numerical value to credit applications and credit bureau data in order to assess likely future performance. Application scores help businesses make decisions such as whether to accept or decline the application.

FICO scores: Credit bureau risk scores produced from models developed by Fair, Isaac and Company, Inc. are commonly known as FICO scores. Fair, Isaac credit bureau scores are used by lenders and others to assess the credit risk of prospective borrowers or existing customers, in order to help make credit and marketing decisions. These scores are derived solely from the information available on credit bureau reports.

BEACON score: A customized FICO score produced at Equifax based on the models developed by Fair, Isaac.

Experian/Fair Isaac Score: A customized FICO score produced at Experian based on models developed by Fair, Isaac.

EMPIRICA: A customized FICO score produced at Trans Union based on the models developed by Fair Isaac.

Behavioral scores: Lenders, especially credit card issuers, will often analyze their current customers' purchasing and payment habits to predict their future behavior. This information may be used to determine credit limit increases or future promotions. In some cases, consumers who are showing very risky behavior may find their accounts closed.

The Credit Score Formula

According to FICO, the factors that make up your credit score fall into five main categories. The categories are listed below along with a percentage reflecting the relative weight they carry in making up your score.

Payment history 35%

Amounts you owe 30%

Length of credit history 15%

New credit 10%

Type of credit in use 10%

Note that of the categories above, the two most important are payment history (past and present), and amounts you owe (your current debt load)

Together, these categories carry 65% of the weight of all information taken from your credit history and are key factors used to determine your credit worthiness on any particular application.