Let’s start with the basics, what a credit score really is. A credit score is NOT a value that identifies who is a better personal finance manager. A credit score IS a number that is calculated to allow lenders to identify which people are the least risky to lend to and who are most likely to produce them the most profit.
That is, a score shows whether a consumer is more or less likely to repay a debt relative to other consumers. The absolute probability that a consumer will not pay a debt will depend on the type of credit product, broader economic conditions, and a wide range of other factors.
Decisions that impact your wallet and money in the bank are dependent on your credit score. Having a low credit score leads to a higher cost of credit which means you’ll be able to enjoy your money less since you’ll have less of it at your disposable.
Having a higher credit score means you have more opportunities to get low interest rate credit when you need it.
This is the part that always makes me shake my head when I hear that credit scores don’t matter. The reality is, like it or not a credit score has a significant impact on your life and money.
Lenders use all sorts of different credit scores to evaluate you. Some might be more dependent on the FICO score which is put out by the Fair Isaac Corporation, while others may turn to the new VantageScore from TransUnion.
Not that this isn’t confusing enough, but the credit scores that consumers see are often not used by lenders at all. These other scores from the different credit reporting agencies are designed for them to sell scores and there has never been a statement that lenders actually use them. But in absence of a single credit score used by all, those consumer credit scores can at least be helpful in letting people know what is helping or hurting their credit score.
Lenders don’t even have to use any of the credit score models in making their lending decisions. There is nothing that prevents a lender from creating and calculating their own internal predicted credit risk score to target their optimum client.
Quite frankly, the credit score landscape is an utter mess. The score is both necessary and not accurate, all at the same time.
The Credit Score Basics
Each of the major credit bureaus, Equifax, Experian, and TransUnion, all maintain separate and often different records. The only way each of the credit reporting agencies (CRAs) get their information is if creditors report it to them. Creditors typically only report to CRAs they have a working relationship with.
Different parts of a credit report are weighed and factored in differently in the calculation of a credit score. For example, a late pay on an account a few years ago is less important than current on-time payments now.
The primary things that can impact a credit score include:
- payment history, including late payments and collection items;
- balances, available credit, and the percentage of existing credit lines being utilized;
- negative public records such as bankruptcy, judgments, and liens;
- length of the credit history and the mix of credit types; and
- evidence of taking on new debt, such as new accounts or inquiries.
Types of Consumer Credit Scores
The elephant in the room when it comes to credit scores is the FICO score. It is estimated they service 90 percent of all credit scores used in extending credit. But even within FICO there are different scoring models.
FICO has worked with creditors and CRAs to develop their own scores for their own purposes. On top of that there have been different versions of the FICO scoring model released over the years and different entities are using different versions.
All scoring models FICO creates are built to generate scores that fall in the range 300 to 850.
The individual credit reporting agencies each produce their own model of a credit score. These models are sold as “educational scores” for consumers to use and are not used in lending decisions.
- Equifax: “Equifax Credit Score.” Produces scores in the range 280-850.
- Experian: “Experian Plus Score.” Produces scores in the range 330-830.
- TransUnion: “TransRisk New Account Score.” Produces scores in the range 300-850. This scoring model was developed to predict performance on new credit accounts, unlike the standard FICO score or the VantageScore, which were developed to predict risk on both new and existing accounts.
New Kid on the Block – VantageScore
The VantageScore was developed in cooperation of the three primary credit reporting agencies. The difference in the VantageScore, released in 2006, is that as new editions are released in it each of the credit reporting agencies have agreed to update their systems to use the same VantageScore version.
The VantageScore models produce scores on the range 501-990.
Credit Score Bottom Line
The bottom line on your credit score is just to use credit responsibly, don’t get overloaded and don’t fall behind on your bills. But even if you did, a credit score is easy to rebuild following a simple formula and a consistent strategy.
Rather than just purchasing a credit score, the best strategy is to obtain a consolidated credit report and evaluate the general health of each credit report to understand if your credit is really in good shape.