Credit Scores
Most lending companies claim that credit scores are used to determine credit worthiness, but their real purpose is to find profitable borrowers that the lenders can loan to. In most cases these are people with a good history of on time payments, but not all of these people are profitable which is why these scores take other things into account.
Let’s look at a specific example, Bob has a 10,000 credit card limit with a 30 day interest free period. Bob uses all $10,000 each month and then pays off his card as soon as he gets billed, because he does this he is not paying interest. In this scenario the credit card company will lose money (because the $10,000 they are loaning Bob isn’t accruing any interest), even though Bob pays his debt on time he isn’t the type of customer that lenders want. This is why most if not all credit scores will not improve if you carry a credit card balance of 0 (also known as a utilization ratio).
When looking at credit scores, it’s important to keep a lenders need for profitability in mind. Credit scores are really used to determine an individuals chance of being profitable, lenders want borrowers who will pay their loans back on time with interest. In some cases they are willing to take on more risky borrowers, but they will expect a higher interest rate in turn. Below we will talk about the most common credit scores, how they are calculated and what each score means.
Index:
- FICO Score
- VantageScore
- NextGen Score
- Credit Score Range
- Credit Score Scale
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FICO Score
In the United States the most commonly used credit score is the FICO score. There are three credit reporting agencies in america and each of these use the FICO analysis to come to their own branded score. Below are the individual names from each reporting agency.
| Credit Reporting Agency | FICO Score |
|---|---|
| Equifax | BEACON® Score |
| Experian | Experian/Fair Isaac Risk Model |
| TransUnion | EMPIRICA® |
The FICO score is the most commonly used credit score in the United States, it’s also used somewhat in Canada and a lot of other countries have based their scoring model on FICO.
This score is a three digit number that can range anywhere from 300 to 850. It’s calculated by looking at the data which is found in each individual’s credit report. Because each credit bureau collects their own data, there are sometimes discrepancies between each score – although these are usually quite small as most data furnishers (the companies that supply the bureaus with the data) typically report this information to all three of the credit bureaus.
The scoring criteria for FICO is well known and can be broken down as follows;
- Payment History – 35% This portion of your score is focused around your payment history. A ‘good’ payment history will include paying all bills on times and no loan defaults. An ‘average’ payment history will include paying most of your bills on time and no defaults on any of your loans. A ‘poor’ payment history is usually indicated by a lot of bills being paid late and in some cases defaults on loans.
- Credit Utilization Ratio – 30% Your credit utilization ratio is worked out by dividing your credit used by the total credit you have available to you. A high credit utilization ratio (0.3+) will negatively affect your score, whilst a score of 0.1-0.3 will improve it. Anything under 0.1 is considered neutral for the most part – this is because lenders cannot earn interest on those who don’t have debt.
- Credit History 15% This is the amount of time you’ve had credit for. The longer you’ve had credit the better, this is because all of your other information is considered more stable as the data has had more time to accumulate. There’s really nothing you can do about this – unless you’re young without credit.
- Recent Searches For Credit 10% Whenever you make a hard inquiry (apply for a new loan) your FICO score usually goes down by around 1-2 points, you’ll typically get these points back within a 6 month period. These inquiries will also show up on your credit report. The real problem arises when you apply for a lot of different loans in a row, this can ding your score by as much as 100 points. This is because while the inquiry appears on your credit report, the result does not. Somebody who has opened a lot of new accounts in a short period of time usually has a high delinquency rate and as such this causes your score to plummet.
- Other Factors 10% The last ten percent of your credit score is made up of other factors, the other factor that accounts for the majority of this 10% is something called types of credit used. Having diversity in the credit types you use is seen as a good thing, so it’s important that you have a history of both installment and revolving loans as this will increase your FICO.
VantageScore
VantageScore is also a three digit number, it ranges from 501 to 990 and it uses letter grading.
| Grade | Score Range |
|---|---|
| A | 901–990 (Excellent) |
| B | 801-900 (Very Good/Good) |
| C | 701–800 (Good/Fair) |
| D | 601–700 (Fair/Bad) |
| F | 501–600 (Very Bad) |
VantageScore was set up by the three credit bureaus in an effort to compete with the FICO score, but has struggled to be adopted by the credit industry at large. Like FICO each agency will usually report a slightly different score even though they all use the same scoring algorithm – this is because each bureau keeps it’s own set of data. VantageScore also has a different scoring breakdown which is as follows: Payment History (32%, how timely and consistent your payments are), Credit Utilization (23% credit used divided by total credit), Credit Balances (15%, total debt), Depth Of Credit (13%, also known as credit length or credit history), Recent Credit (10% how recent and how many new hard inquiries has there been) and Available Credit (7% what’s the total amount of credit that can be accessed – for example could $100,000 be spent within a week?). In 2010 the credit bureaus released VantageScore 2 which is basically the same with some minor tweaks and a rebranding.
NextGen Score
The company behind FICO is also responsible for the NextGen score – this score started to get traction as it was seen as a way for lenders to increase the amount of people they could loan to whilst keeping defaults at similar levels. Unfortunately when the the global financial crisis hit in 2008 this score quickly declined in popularity. This is because the NextGen score was suggesting those that were applying for sub prime mortgages should be accepted as they were low risk. As we all know it soon became apparent that these borrowers were not high quality and actually had high rates of defaulting – causing lenders that used NextGen a lot to loose a great deal of money.
Free Credit Score
Credit Score Range
A credit score range will depend on which credit score you’re talking about as there are several types. We’ve compiled credit score ranges for all of the major credit scores and listed them below.
FICO Credit Score Range
| Minimum Score | Maximum Score |
|---|---|
| 300 | 850 |
The FICO score is the most commonly used score and generally when people say credit score, they actually mean FICO score. This score can range anywhere from 300 to 850. The higher your score, the better.
Here are some other FICO score stats: the average score is 693, the median score is 723, the highest score is 850 and the lowest is 300. 60% of the scores are located between 650 and 799.
| FICO Score | Grade |
|---|---|
| 720-850 | Excellent |
| 700-719 | Very Good |
| 675-699 | Good |
| 620-674 | Fair |
| 560-619 | Bad |
| 500-619 | Very Bad |
VantageScore Range
| Minimum Score | Maximum Score |
|---|---|
| 501 | 990 |
The VantageScore is much less popular than FICO, accounting for around 10% of all scores (FICO accounts for the other 90%).
Credit Score Scale
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