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Credit scoring is a scientific method of assessing credit risk, which allows lenders to make more informed decisions. There are 3 major credit repositories (Equifax, Experian and TransUnion) and a lender will generally use the lower of the middle scores of the borrowers to determine the credit grade and risk based pricing for interest rates. Each credit bureau produces scores based on data about an applicant’s credit history and payment patterns. The score sums up what the applicant’s past payment performance and current usage say about the level of credit risk. Because the score is a composite of all of the applicant’s credit information, no single factor – like a bankruptcy, inquiry or late payment – will be the sole cause of an unacceptable score. There are also items which may or may not be reported by creditors to all 3 credit companies, which can result in a different score from one repository to another.
Scoring models DO NOT consider: race, gender, religion, marital status, income, nationality, address or employment. Scoring models DO analyze: all the credit information stored in a bureau’s credit file on an applicant at the time of the request.
1. Past Payment Performance (35% of the score’s weight)
The fewer late payments, judgments, liens or collections the better. A 30-day late today will have greater negative impact on the score than a bankruptcy 5 years ago with clean credit since.
2. Credit Utilization (30% of the scores weight)
Low Balances on several cards is better than high balances on a few cards. It is preferable to pay down credit card balances to less than 30% of the available credit line.
3. Credit History (15% of the scores weight)
The longer accounts have been opened with no late payments, the lower the risk indication. Opening new accounts and closing seasoned accounts will negatively impact a credit score.
4. Types of Credit In Use (10% of the scores weight)
Finance company lines will score lower than bank lines and department store lines, and can drive a score down if the only type of credit in the file.
5. Inquiries – New Applications for Credit (10% of the scores weight)
Looking for new credit can mean higher risk if several credit cards are applied for in a short period of time.
Collection accounts and charge offs will not necessarily disappear from a credit file after seven years, if unpaid, those accounts could be sold to collection possibly resetting the clock. Judgments and bankruptcies stay in credit files up to 10 years and unpaid tax liens stay in a credit file forever. Just because an account is paid to zero, it will continue to appear in the file for the seven years before being purged. The only way to eliminate the impact of an inaccuracy on a score is to have the inaccuracy modified at the repository level. Until the issue is modified at the repository, the applicant’s score will be negatively impacted. Consumers must pay their accounts on time, use credit conservatively (keep balances below 30% of available credit), apply for new credit very sparingly, and refrain from “credit surfing”. With no recent “lates”, no additional increases to account balances or brand new accounts opened, the applicant’s score should go up. Remember, credit information about past payment performance, credit utilization and credit history carries the most weight in a credit score. Credit scores automatically improve, as a consumer’s overall credit picture gets better.
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