Credit Scoring

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What is credit scoring?
A way that creditors determine whether to give you credit or not.

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 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. 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:

race
sex
marital status
national origin
religion
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 a home.

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 include:

Low Income
Length of Employment"

Unacceptable reasons include:

Not meeting their minimum standards
"You didn't receive enough points on our credit scoring system"
"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.

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 denied.

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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