What is credit scoring
Ever wonder 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.
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. To get copies of your report, contact the three major credit
reporting agencies:
These agencies may charge you up to $9.00 for your
credit report. For a limited time, you can get a free copy of your credit
report from ConsumerInfo.
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.
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.
Where can you get more information?
The FTC works for the consumer to prevent fraudulent, deceptive and
unfair business practices in the marketplace and to provide information to
help consumers spot, stop and avoid them. To file a complaint call
toll-free, 1-877-FTC-HELP (1-877-382-4357),
or use the online
complaint form. The FTC enters Internet, telemarketing, identity
theft and other fraud-related complaints into Consumer
Sentinel, a secure, online database available to hundreds of
civil and criminal law enforcement agencies in the U.S. and abroad.
| FEDERAL
TRADE COMMISSION |
FOR
THE CONSUMER |
| 1-877-FTC-HELP |
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