Credit Scoring

A credit score is a number that helps a lender determine how likely an individual is to repay a loan, or make credit payments on time. When a lender requests a credit report and score from a credit reporting agency, the score is calculated from a "scorecard" or scoring model - a mathematical equation that evaluates many types of information from the applicant's credit report at that agency. By comparing this information to the patterns in thousands of past credit reports, scoring identifies one's level of credit risk.

What is Credit Scoring?

You may wonder how a creditor can look at all the information on your credit report and make a fair decision about your credit. Along with the credit report, lenders can also buy a credit score based on the information in the report. Credit scoring is a scientific method that uses statistical models to assess an individual's credit worthiness based on their credit history and current credit accounts. Credit scoring was first developed in the 1950s, but has come into increasing use in the last two decades.

A computer-generated score is compiled using information from an individual's credit report. Creditors-especially those in the mortgage industry-frequently use the scores when deciding who receives loans.

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.

Key Points

• Your credit score is determined by a combination of many factors. No one piece of information or factor will determine your score.
  
  
• Credit scoring systems assign points to factors that help predict who is most likely to repay a debt. Your credit score helps predict how likely it is that you will repay a loan and make the payments when due.
  
  
• Your score only looks at information in your credit report. Lenders, however, look at many things when making a credit decision, including your income and the kind of credit you are applying for.
  
  
• The most commonly used scoring systems give you a number from the mid-300s to the mid-800's, with high scores being better. Scores vary depending on the type of credit you are seeking. For example, recent auto loan history is weighed more heavily when applying for a car loan.