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mark@AREGmail.com
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Calculating Your FICO Score

When a customer fills out an application for credit from a bank, store or credit card company, their information is forwarded to a credit bureau. The credit bureau matches the name, address and other identifying information on the credit applicant with information retained by the bureau in its files. That's why it's very important for creditors, lenders and others to provide accurate data to credit bureaus. This information is used by lenders such as credit card companies to determine an individual's credit worthiness; that is, determining an individual's willingness to repay a debt. The willingness to repay a debt is indicated by how timely past payments have been made to other lenders. Lenders like to see consumer debt obligations paid on a monthly basis. There has been much discussion over the accuracy of the data in consumer reports. However, the only scientifically researched studies that include sample sizes large enough to be valid have generally concluded the data in credit reports is very accurate. The credit bureaus point to their own study of 52 million credit reports to highlight that the data in reports is very accurate. The Consumer Data Industry Association testified before Congress that less than two percent of those reports that resulted in a consumer dispute had data deleted because it was in error.

If a consumer disputes some information in a credit report, the credit bureau has 30 days to verify the data. Over 70 percent of these consumer disputes are resolved within 14 days and then the consumer is notified of the resolution. The Federal Trade Commission states that one large credit bureau notes 95 percent of those who dispute an item seem satisfied with the outcome. The other factor in determining whether a lender will provide a consumer credit or a loan is dependent on income. The higher the income, all other things being equal, the more credit the consumer can access. However, lenders make credit granting decisions based on both ability to repay a debt (income) and willingness (the credit report) as indicated in the past payment history. These factors help lenders determine whether to extend credit, and on what terms. With the adoption of risk-based pricing on almost all lending in the financial services industry, this report has become even more important since it is usually the sole element used to choose the annual percentage rate (APR), grace period and other contractual obligations of the credit card or loan.

Credit ratings vary from a scoring model to another, but in general the FICO scoring system is the standard. The factors are similar and may include:

Payment history (35% contribution on the FICO scale) - A record of negative information can lower a consumer's credit rating or score. In general risk scoring systems look for any of the following negative events; charge offs, collections, late payments, repossessions, foreclosures, settlements, bankruptcies, liens, and judgements. Within this category FICO considers the severity of the negative item, the age of the negative items and the prevalence of negative items. Newer is worse than older. More severe is worse than less severe. And, many is worse than few.

Debt (30% contribution on the FICO score) - This category considers the amount and type of debt carried by a consumer as reflected on their credit reports. There are three types of debt considered.

Revolving debt - This is credit card debt, retail card debt and some petroleum cards. And while home equity lines of credit have revolving terms the bulk of debt considered is true unsecured revolving debt incurred on plastic. The most important measurement from this category is called "Revolving Utilization", which is the relationship between the consumer's aggregate credit card balances and the available credit card limits, also called "open to buy." This is expressed as a percentage and is calculated by dividing the aggregate credit card balances by the aggregate credit limits and multiplying the result by 100, thus yielding the utilization percentage. The higher that percentage the lower your score will likely be. This is why closing credit cards is generally not a good idea for someone trying to improve their credit scores. Closing one or more credit card accounts will reduce your total available credit limits and likely increase the utilization percentage unless the cardholder reduces their balances at the same pace.

Installment debt - This is debt where there is a fixed payment for a fixed period of time. An auto loan is a good example as you're generally making the same payment for 36, 48, or 60 months. While installment debt is considered in risk scoring systems it is a distant second in its importance behind the revolving credit card debt. Installment debt is generally secured by an asset like a car, home, or boat. As such, consumers will use extraordinary efforts to make their payments so their asset isn't repossessed by the lender for non-payment. Open debt - This is the least common type of debt. This is debt that must be paid in full each month. An example is any one of the variety of credit cards that are "pay in full" products. The American Express Green card is a common example.

Open debt is treated like revolving credit card debt in older version of the FICO scoring system but is excluded from the revolving utilization calculation in newer versions.

Time in file (Credit File Age) (15% contribution on the FICO scale) - The older your credit report the more stable it is, in general. As such, your score should benefit from an old credit report. This "age" is determined two ways; the age of your credit file and the average age of the accounts on your credit file. The age of your credit file is determined by the oldest account's "date opened", which sets the age of the credit file. The average age is set by averaging the age of every account on the credit report, whether open or closed.

Account Diversity (10% contribution on the FICO scale) - Your credit score will benefit by having a diverse set of account types on your credit file. Having experience across multiple account types (installment, revolving, auto, mortgage, cards, etc.) is generally a good thing for your scores because you're proving the ability to manage different account types.

The Search for New Credit (Credit inquiries) (10% contribution on the FICO scale) – An inquiry is noted every time a company requests some information from a consumer's credit file. There are several kinds of inquiries that may or may not affect one's credit score. Inquiries that have no effect on the creditworthiness of a consumer (also known as "soft inquiries"), which remain on your credit reports for 6 months and are never visible to lenders or credit scoring models, are:

  • Prescreening inquiries where a credit bureau may sell a person's contact information to an institution that issues credit cards, loans and insurance based on certain criteria that the lender has established.
  • A creditor also checks its customers' credit files periodically. This is referred to as Account Management, Account Maintenance or Account Review.
  • A credit counseling agency, with the client's permission, can obtain a client's credit report with no adverse action.
  • A consumer can check his or her own credit report without impacting creditworthiness. This is referred to as a "consumer disclosure" inquiry.
  • Employment screening inquiries
  • Insurance related inquiries
  • Utility related inquiries

Inquiries that can have an effect on the creditworthiness of a consumer, and are visible to lenders and credit scoring models, (also known as "hard inquiries") are made by lenders when consumers are seeking credit or a loan, in connection with permissible purpose. Lenders, when granted a permissible purpose, as defined by the Fair Credit Reporting Act, can "pull" a consumer file for the purposes of extending credit to a consumer. Hard inquiries can, but don't always, affect the borrower's credit score. Keeping credit inquiries to a minimum can help a person's credit rating. A lender may perceive many inquiries over a short period of time on a person's report as a signal that the person is in financial difficulty, and may consider that person a poor credit risk.

  • 35% - Payment History: Negative information. 
  • 30% - Debt: How much and what type?
  • 15% - Length Of Credit History: This is how long you've had credit
  • 10% - Credit Diversity: This is the different types of credit experience you've had
  • 10% - Inquiries (hard): This is when a creditor checks your credit report

Acquiring and understanding credit reports and scores
There are many businesses that aim to make money by providing services to consumers to check their credit reports and confirm the information in them. These companies advertise heavily. In the US, the Fair Credit Reporting Act and its amendments require that any national consumer credit reporting agency (including Experian, Equifax, and TransUnion) and any national specialty consumer reporting agency (including Innovis, PRBC, Teletrack) provide a free copy of the credit reports for any consumer who requests it, once per year. Free annual credit reports for Experian, Equifax and TransUnion may be requested at https://www.annualcreditreport.com. Note that many imposter websites with names similar to www.annualcreditreport.com exist, and users will see promotions for extra credit-checking services that cost money. Carefully following the process and declining for-pay services will allow users to get their free annual credit reports. Also note that the free reports do not include the consumer's credit score. Rather, they provide a list of accounts so users can confirm that no erroneous information is on the reports. Information from the GSA Federal Citizen Information Center (US government) is available for free download in .pdf form at http://www.pueblo.gsa.gov. Look for the pamphlets "Building a Better Credit Report" and "Your Credit Scores."

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