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What is credit scoring?
A way that creditors determine whether to give you credit
The credit scoring process includes Information about you
and your credit experiences, such as paying back bills, the
number and type of open accounts, payments you made late,
collection activity, outstanding debt, and the age of your
accounts, are 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. This system awards points for each factor
that helps predict who is most likely to repay a debt. A total
number of points, or credit score, will help predict how creditworthy
you are. The main thing creditors are loking for are how likely
it is that you will repay a loan and make the payments when
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. To get copies of your
report, contact the three major credit reporting agencies:
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?
A creditor selects a random sample of its customers or a sample
of similar customers and analyze it statistically to identify
characteristics that relate to creditworthiness. Each of these
factors are then assigned a weight based on how strong a predictor
it is of who would be a good credit risk. Each bank or 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.
A credit scoring system may not use certain characteristics
under the equal credit opportunity act:
- marital status
- national origin
- age - creditors are
allowed to use age in some scoring systems. Although it
must give equal treatment to elderly applicants.
What can I do to improve my credit score?
First it helps to learn how the system works if you read the
techniques creditors use to evaluate your credit and know
that credit scoring models are complex and often vary among
creditors and for different types of credit. Remember that
improving your score is not a quick fix and may take some
time to improve your score significantly.
- Have you paid your bills on time? Payment history typically
is a huge factor used. 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
Concentrate on the following to improve your score
under most models:
- paying your bills on time
- paying down outstanding balances
- staying away from new debt.
Denied credit or the terms are not what you wanted?
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. Non-specific reasons for denial are not legal
and it is your right to ask the creditor to be specific.
An example of Acceptable reasons for denial
- Low Income
- Length of Employment"
Unacceptable reasons include:
- Not meeting their minimum standards
- "You didn't receive enough points on our credit scoring
- "You do not seem prepared"
Denied credit because you are too close to your credit
limits on your charge cards or you have too many credit card
accounts? Try paying off your balances or closing
some accounts then reapplying.
What do you do if you are Denied credit because of information from a credit
report? 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
had to say specifically. This information is free only 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
The bottom line is if you didn't get the
rate or credit terms you wanted or was denied credit, ask
the creditor if a credit scoring system was used and ask what
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. If you feel
you have dealt with an unfair or deceptive business send the
FTC a buzz at www.ftc.gov or 1-877-FTC-HELP..
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