Ever question how a creditor decides whether to grant you credit? For years, creditors have been using credit-scoring systems to determine if you'd be a good risk for credit cards and auto loans. More recently, credit scoring has been used to help creditors evaluate your ability to repay home mortgage loans. Here's how credit scoring works in helping decide who gets credit -- and why.

Answer True or False:

Being a few days late, one time, can hurt your credit score

Paying credit cards in full, every month, hurts your credit score

Accepting every credit card offer your get will improve your credit score.

If you never miss a payment you will have Perfect Credit.

Not many people know the answer to all four is False.

Credit scores are based on a point system developed from a statistical review of one million borrowers from all over the US. The measurable characteristics of the borrowers who defaulted on their bills were compared to borrowers who paid on time.

Credit scores range from 380 - 830. Higher scores are given to people who are less likely to default. About 70% of US residents have scores above 700, or "A" credit.

Borrowers who have B, C, D, or E credit will either be asked to pay higher interest rates or find it very difficult to obtain credit at any cost.

What is credit scoring?
Credit scoring is a system creditors use to help determine whether to give you credit.

Information about you and your credit experiences, such as your bill-paying history, the number and type of accounts you have, late payments, collection actions, outstanding debt, and the age of your accounts, is collected from your credit application and your credit report. Using a statistical program, creditors compare this information to the credit performance of consumers with similar profiles. A credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points -- a credit score -- helps predict how creditworthy you are, that is, how likely it is that you will repay a loan and make the payments when due. Because your credit report is an important part of many credit-scoring systems, it is very important to make sure it's accurate before you submit a credit application.

Why is credit scoring used?
Credit scoring is based on real data and statistics, so it usually is more reliable than subjective or judgmental methods. It treats all applicants objectively. Judgmental methods typically rely on criteria that are not systematically tested and can vary when applied by different individuals.

How is a credit-scoring model developed?
To develop a model, a creditor selects a random sample of its customers, or a sample of similar customers if their sample is not large enough, and analyzes it statistically to identify characteristics that relate to creditworthiness. Then, each of these factors is assigned a weight based on how strong a predictor it is of who would be a good credit risk. Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.

Under the Equal Credit Opportunity Act, a credit scoring system may not use certain characteristics like -- race, sex, marital status, national origin, or religion -- as factors. However, creditors are allowed to use age in properly designed scoring systems. But any scoring system that includes age must give equal treatment to elderly applicants.

Scoring Characteristics and Their Weight

History of Paying on time 35%

Credit card balances vs. limits 30%

Length of credit experience 15%

Mix of credit card & fixed payments 10%

Frequency of requesting credit 10%

What can I do to improve my score?
Credit scoring models are complex and often vary among creditors and for different types of credit. If one factor changes, your score may change -- but improvement generally depends on how that factor relates to other factors considered by the model. Only the creditor can explain what might improve your score under the particular model used to evaluate your credit application.

Nevertheless, scoring models generally evaluate the following types of information in your credit report:

Have you paid your bills on time? Payment history typically is a significant factor. It is likely that your score will be affected negatively if you have paid bills late, had an account referred to collections, or declared bankruptcy, if that history is reflected on your credit report.

What is your outstanding debt? Many scoring models evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, that is likely to have a negative effect on your score.

How long is your credit history? Generally, models consider the length of your credit track record. An insufficient credit history may have an effect on your score, but that can be offset by other factors, such as timely payments and low balances.

Have you applied for new credit recently? Many scoring models consider whether you have applied for credit recently by looking at "inquiries" on your credit report when you

apply for credit. If you have applied for too many new accounts recently, that may negatively affect your score. However, not all inquiries are counted. Inquiries by creditors who are monitoring your account or looking at credit reports to make "prescreened" credit offers are not counted.

How many and what types of credit accounts do you have? Although it is generally good to have established credit accounts, too many credit card accounts may have a negative effect on your score. In addition, many models consider the type of credit accounts you have. For example, under some scoring models, loans from finance companies may negatively affect your credit score.

Scoring models may be based on more than just information in your credit report. For example, the model may consider information from your credit application as well: your job or occupation, length of employment, or whether you own a home.

To improve your credit score under most models, concentrate on paying your bills on time, paying down outstanding balances, and not taking on new debt. It's likely to take some time to improve your score significantly.

Pay all loans and credit cards promptly.

Have no more than 5 Bankcards, like Visa & MasterCard. If you have 6+ pay off balances and write to request the cards be closed.

Pay down all store credit cards, but do not close these accounts.

Avoid balances on American Express and Citicorp cards because these companies do not report a limit, only the current balance, so it looks like these cards are "maxed out’ all of the time.

Switch unsecured debt to secured if possible. Use a car title or a home equity for bill consolidation or education loans.

Pay off loans to finance companies if possible. Credit scores recognize high interest lenders like Household, Beneficial, Providian, and Capital One.

Have over 25 months of recorded payment history. Unfortunately rent and utility payments do not count, unless payments are late.

Settle and pay off any garnishments, foreclosures, lawsuits and bankruptcies. Their impact fades after a few years, but does not disappear for 10 years. Even if you are not legally required to repay the debt, as with some bankruptcies, making voluntary payments can improve your credit score.

How good is your credit score?  Most people are unaware of their credit rating and that's a dangerous situation to be in, especially when you buy a car, and car dealers will walk all over you, because they know more about your financial history than you do.  It should be the other way around.  If you are planning to buy furniture, a car, or a home, you could be turned down if your payment history is spotty, or even because of errors in your credit report.  It's the stupid !

Little things, like not getting the last utility bill paid when you move out of an apartment can keep you from getting credit later on.   Sometimes the bill does not get forwarded to you, now you have a charge off on your credit report for a late or unpaid bill.  Did you ever overdraft on your checking account?  It's probably on your credit report, and you should see about getting it removed.

What your credit score tells about you
Credit scores are usually in the 300-900 range, and the higher the better. Credit scores are generated by the credit bureaus when they print your credit report.   They do it using software from the Fair Isaac Company, hence the name FICO score.   Calculating your credit score is very complicated, based on over 100 parameters in your credit file, including length of credit history, number of open accounts, loans, mortgages, public records, and others. There are other companies that generate credit scores, but the Beacon FICO score is what most lenders use. When you get your credit report from Equifax they call it ‘Score Power’. Your credit score is a predictor for lenders, of your ability to pay.  The higher your score, the more likely it is that you'll pay back your creditors on time.  According to Equifax 51% of all the people with a credit score from 550-599 will default on their credit.  That's scary.

What A Low Credit Score Means To You
Your credit score is the single most important factor determining whether you'll get approved for a mortgage, car loan, refinance loan, or credit cards, and what your APR will be.  If your score is low, you'll pay very high interest rates, up to 23%.  Most people are also unaware that their credit score also affects how much you'll pay for car insurance rates too. Many insurance companies run a credit check on you before selling you insurance. 

Maintaining your high credit score should be an ongoing process, not a task you rush into when you need to apply for new credit, home loans, or car loans.  In fact, that's the worst time. The reason is banks will reject you if you have disputed any items on your credit report, until it is resolved.  It can take 60 days to even start cleaning up your credit score, so don't apply for any new credit until all disputes are resolved and you verified the FICO Score --- You have been warned!  I have seen people get rejected for disputing while closing accounts. Wait until the accounts are closed and any credit bureau investigations and disputes are complete. Right now, you should be asking yourself "How good is my credit score?"

How reliable is the credit scoring system?
Credit scoring systems enable creditors to evaluate millions of applicants consistently and impartially on many different characteristics. But to be statistically valid, credit-scoring systems must be based on a big enough sample. Remember that these systems generally vary from creditor to creditor. Although you may think such a system is arbitrary or impersonal, it can help make decisions faster, more accurately, and more impartially than individuals when it is properly designed. And many creditors design their systems so that in marginal cases, applicants whose scores are not high enough to pass easily or are low enough to fail absolutely are referred to a credit manager who decides whether the company or lender will extend credit. This may allow for discussion and negotiation between the credit manager and the consumer.

What happens if you are denied credit or don't get the terms you want?
If you are denied credit, the Equal Credit Opportunity Act requires that the creditor give you a notice that tells you the specific reasons your application was rejected or the fact that you have the right to learn the reasons if you ask within 60 days. Indefinite and vague reasons for denial are illegal; so ask the creditor to be specific. Acceptable reasons include: "Your income was low" or "You haven't been employed long enough." Unacceptable reasons include: "You didn't meet our minimum standards" or "You didn't receive enough points on our credit scoring system."

If a creditor says you were denied credit because you are too near your credit limits on your charge cards or you have too many credit card accounts, you may want to reapply after paying down your balances or closing some accounts. Credit scoring systems consider updated information and change over time.  Sometimes you can be denied credit because of information from a credit report. If so, the Fair Credit Reporting Act requires the creditor to give you the name, address and phone number of the credit reporting agency that supplied the information. You should contact that agency to find out what your report said. This information is free if you request it within 60 days of being turned down for credit. The credit reporting agency can tell you what's in your report, but only the creditor can tell you why your application was denied.

If you've been denied credit, or didn't get the rate or credit terms you want, ask the creditor if a credit scoring system was used. If so, ask what characteristics or factors were used in that system, and the best ways to improve your application. If you get credit, ask the creditor whether you are getting the best rate and terms available and, if not, why. If you are not offered the best rate available because of inaccuracies in your credit report, be sure to dispute the inaccurate information in your credit report.

What Should Your Credit Score Be For Credit & Loan Approval?
 

If your credit score is above 680, you are considered a "prime borrower" and will get a good APR on your home loan, car loan, or credit card. 

If your credit score is below 680, you are "sub prime", and will pay much higher APR on your loan.  Below 550, you can forget about a home loan, car loan, or credit card.

A car dealer shouldn't know more about your FICO Score than you. They can use errors in your credit report to scam you into higher interest rates. So get your credit score now. In 2001 it became possible for you to get your own Beacon FICO Credit Score when you get your credit report online.  Congress fought hard for your right to get at your credit score, so you better use it. Previously lenders kept this beacon score secret from you, so they could charge you higher APR. Get your Credit Score so dealers who run your credit report can't lie and say your score was low just so they can charge you higher APR.  This happens all the time, and now you must use your power to stop it.

Credit score myths: "I've never missed a payment. My score must be high!” A lot of mis-informed people think this.  This could not be more wrong. I'm amazed how many people I know were very upset when they got their credit score and found out just how low it was. Sure paying on time is one of the best things for your FICO score, but it's only one of over 100 variables making up your credit score. Having several open accounts does just as much damage to your credit score, because there is potential for you to run up your credit limit on all your accounts. People with good credit tend to have too much credit, and too many old accounts that they never use. Lenders view that as a risk. A client’s score may be ok, but need improving by closing half a dozen computer store and department store cards which they no longer use, that will drag down your score. You should get your credit history report, especially if you have not seen it in the last year. These are the steps to take before you apply for a home loan, a car loan, or credit cards:

1. Get your Credit Score and credit history, verify all the information is correct.

2. Close old accounts, they are excess luggage and dragging down your score.

3. Pay down as much of your credit card debt as you can.

4. Remove any incorrect addresses or other errors.

5. Try to get any "Charge Offs" removed. Talk to your creditors, not the bureaus.

6. Wait until disputes resolve before applying for home loans, car loans, etc.

7. Aim for a credit score of at least 680 to be sure you'll get the best APR.

Is it possible to never miss a payment and have less than A credit?

Yes. Having growing balances of unsecured loans and credit card balances in the last two years will lower your credit score dramatically. This happens to many new home owners who, after getting their mortgage, borrow for furniture, home improvements, landscaping, etc.

Does my age have anything to do with my credit score?

No. Not even if you are young or formerly young. The length of time you have had credit in your own name matters. Parents can help young people get started by cosigning a low limit credit card, and then coaching their child to pay promptly and not accumulate other unsecured debts. Retirees should not hesitate to apply for credit, even if it is for their first credit card.

Do I have to have a paycheck to qualify for credit?

Not necessarily. Income from all verifiable sources must be considered equally: pensions, investments, alimony, and child support. Self-employed people can use their tax returns for documentation. Rental property income requires signed leases and bank records.

Household income can qualify a stay-at-home parent for credit in their own name. If something unpredictable happens to the primary wage earner the surviving parent will have an established credit history.

If my low credit score means I must pay more interest on my loans, can that ever change?

Yes, and more quickly than you may think. At our credit union you can apply to have your credit re-scored after you obtain a loan. If your score has improved sufficiently your interest rate will be changed to whatever the current rate is for that type of loan. Review the list of ‘What you can do to improve you credit score’ above.

How to Check Your Credit Report

Once every two years you should request copy of your credit report directly from each of the three national credit-reporting agencies. There may be a minimal charge. Should you find errors you report them directly to the reporting agencies or to a reputable credit repair organization such as NuLife 2.

Experian (NCAC)  (800) 682-7654  www.experian.com

Equifax (CSC)  (800) 685-1111        www.equifax.com

Trans Union (800) 916-8800            www.transunion.com