The development of credit scores helped to advance loan decisions from an art practiced by loan officers to a science. In 1956 engineer Bill Fair and mathematician Earl Isaac founded the Fair Isaac company to do credit scoring. Mathematical formulas and computers would allow for fast, objective and accurate predictions of default probability. The so-called "classic" Fair Isaac COrporation (FICO) model was developed in 1989. There was a sharp increase in the use of FICO in 1995 when Fannie Mae and Freddie Mac endorsed the use of FICO for mortgage lenders to predict the probability of defaulting on a loan. FICO scores are not influenced by current income, employment history or property values — and these factors in addition to FICO scores will influence the decisions of creditors in granting loans or mortgages.
FICO scores were not available to consumers until February 2000 when the Internet lender E−Loan defied Fair Isaac by giving FICO scores to prospective applicants. During the course of one month 25,000 customers took advantage of the service until the three credit scoring agencies cut-off E−Loan from access to credit scores. Legal appeal was made by E−Loan. California legislation soon required the agencies to disclose scores. The agencies soon discovered that the scores could be marketed to consumers.
Newer credit scoring systems such as NextGen ("Next Generation") and VantageScore have not succeeded in displacing FICO.
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FICO classic risk model scores range from 300 to 850. People with lower FICO scores pay higher interest rates when they are granted credit. The following table illustrates the percentage of the United States population lying within specified score ranges, the percentage of borrowers who reach 90 days past due or worse for any credit account in a two year period ("default"), and approximate monthly payments for a $25,000 automobile loan in May 2007 (higher monthly payments for people with lower scores reflect higher interest rates). Scores below 620 are regarded as "High Risk" and scores above 780 are regarded as "Low Risk".
% OF POPULATION
% OF "DEFAULT"
People with lower credit scores pay higher mortgage rates and pay more for automobile insurance. The advent of credit scoring changed many loan decisions from "accept/decline" to "higher rates for higher risk".
Different agencies give different meanings to the same credit scores. For more information on this matter see: What is a good credit score?
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FICO credit scores are based on the following factors:
LENGTH OF CREDIT HISTORY
RECENT CREDIT APPLICATIONS
TYPE OF CREDIT USED
Payment History (35%) includes such potential negatives as unpaid debts (bankruptcy, foreclosures, court judgments, tax liens, collection lawsuits, etc.) and missed payments. Recency, frequency and severity of debt are all important. The more recent the debt the stronger the negative impact. United States Federal law requires removal of bankruptcy information from the credit record after ten years, whereas civil judgments and collections must be removed after seven years. Tax lien information can remain on the credit record indefinitely. Severity of late payment falls in the ranges of over 30−days, over 60−days and over 90−days;. A late payment of a few days is not counted.
Amount Owed (30%) refers to the ratio of credit used to credit limit. The average American uses about one third of his or her available credit limits. Maximum use of credit limits very negatively impacts credit score. People who pay their credit card balances in full every month may nonetheless score poorly if they are making high use of available credit. What matters is the ratio of credit used to credit limit on the day the creditors report balances to the credit agencies. To score well on amount owed, balances should always be below 30% of credit limit. Small balances on a number of credit cards are better than a large balance on a single credit card.
Length of Credit History (15%) considers both the age of the oldest account and the average age of all accounts. The longer you have had credit, the better. It is a bad idea to close out the oldest credit card account. (Closing out any credit card account can hurt your score by lowering your credit limit.) The oldest account of the average American is 14 years.
Recent Credit Applications (10%) lowers the credit score. The greater the number of new accounts or loans applied for and opened — and the more recently those applications were made — the lower the resulting credit score. People actively seeking credit represent greater risk. The average American has not opened a new account in 20 months. Many credit applications associated with shopping for lower mortgage or automobile loan rates within a 14−day period count as a single inquiry, and do not harm the credit score very much. A single credit inquiry generally will not lower the overall score more than 5 points.
Type of Credit Used (10%) is positively affected by having both revolving accounts (credit cards, department store charge cards, etc.) and installment accounts (auto loans, mortgage, personal loans, etc.) on the credit record. Loans need not be current to show on the credit record.
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Just as Dun & Bradstreet is a credit reporting agency for businesses, TransUnion, Equifax and Experian are credit-reporting agencies for consumers. Credit-reporting agencies calculate and distribute credit scores for creditors and consumers. Creditors, not the credit reporting agencies, make decisions whether to extend credit and the associated interest rate.
Each credit-reporting agency has its own name for its FICO scores:
|Experian||Experian/Fair Isaac Risk Model|
Consumers can obtain their credit reports directly from each agency and complain about their credit reports directly to each agency. Identity theft can also be reported to the agencies.
|TransUnion||PO Box 1000|
Chester, PA 19022
|Equifax||PO Box 740241 |
Atlanta, GA 30374
|Experian||PO Box 2002 |
Allen, TX 75013
Equifax has websites for Argentina, Brazil, Canada, Chile, El Salvador, Peru, Spain, the United Kingdom and Uruguay. There is no unification of credit scores between countries, however. A person moving from Canada to the United States must begin again with no credit rating, despite a long credit history in Canada. Credit ratings are country-specific.
Fair Isaacs offers direct access to FICO scores at its www.myfico.com website. FICO Deluxe provides consumers with one-time credit reports for all three credit reporting agencies (something which can be obtained for free directly from each credit agency once yearly).
It is better to discover and correct errors in one's credit report before applying for credit than after having an application declined. Incorrect entries in the report may even signal identity theft. The best way to dispute errors in credit reports is by certified mail. It is a good practice to review credit reports from all three reporting agencies at least once per year and 60 days prior to making any major purchase on credit.
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Identity Theft Clearinghouse reported in 2002 that 42% of reported identity thefts involved credit card fraud (most often new accounts opened in the names of the victims), 22% of cases involved utility services (usually cell phones) activated under assumed identities and 17% of cases involved bank fraud (usually unauthorized checks written in the victim's name).
Every legal United States resident is entitled to receive a free credit report from each credit reporting agency once every twelve months. To obtain your free reports you can phone 1−877−322−8228 or go to www.annualcreditreport.com.
So-called "pre-approved" credit offers are rarely really pre-approved. These are often marketing schemes which can lead to making credit applications for cards giving unattractive interest rates. To prevent all three credit agencies from giving your address to companies marketing credit cards, phone 1−888−567−8688 or send your name, address and Social Security Number to:
Direct Marketing Association
Mail Preference Service
PO Box 9008
Farmingham, NY 11735
Complaints about the credit reporting agencies can be directed to the Federal Trade Commission at www.ftc.gov or phone 1−877−382−4357 (877−FTC−HELP) or send your complaint with your name, address and Social Security Number to:
Federal Trade Commission — crc
600 Pennsylvania Avenue NW
Washington, DC 20580
To find a lawyer for help with credit problems, contact the National Association of Consumer Advocates at 1−202−452−1989.
The Wikipedia entry on Credit score (United States) provides more information on credit scoring and credit reports.
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