BestCredit™

Understanding credit ratings is an integral part of having a successful credit repair program.

Without a fundamental understanding of credit ratings, a credit score can actually go down with the removal of the wrong bad credit entries.

FICO's decision to release detailed information about its credit scoring model in 2002 came as a result of intense pressure from Congress and consumer advocacy groups. It has given consumers a significant leg up. Now we don't have to make as many guesses about how to increase a credit rating.

For example, in the past it was assumed that a person's age played a role in scoring. This was a reasonable conclusion, since older people had better scores overall. But in reality, it's the age of the credit report that matters—an important difference. New knowledge such as this can prove very powerful in devising individualized tactics and strategies for improving credit scores.

Sophisticated software is used to determine a credit rating.

Credit ratings are derived using software that analyzes the data contained in a report. This software uses algorithms to come up with a solution for analyzing a finite number of variables. One big advantage to this is that everyone is treated equally by the software, as the software does not discriminate as people sometimes do; it is indifferent to someone's religion or hairstyle, for example.

Don't be alarmed when you order your credit reports and find that your credit scores from each of the credit bureaus are different. The discrepancies can be attributed in part to the fact that certain accounts either don't show up on each report or are reported differently. It's also because the bureaus use different scoring models. Equifax uses the FICO score, while Experian and Trans Union use their proprietary models. Yet you can obtain a FICO score for each of the individual credit bureau reports directly through the consumer arm of FICO, myFICO (www.myfico.com) or one of its affiliates.

There are other credit scoring models.

In addition to the FICO score, which Equifax markets under the name Score Power, the other two credit scoring models used by lenders are Trans Union's TrueCredit and Experian's Plus Score. To illustrate how confusing this can get, compare the following scores, all calculated for the same individual in the same hour (and note how each compares to the FICO score calculated for the same set of data):

Experian/Plus Score (Range: 330-830)
Plus Score: 702
(FICO Score: 711)

Equifax/Score Power (Range: 300-850)
Score Power: 687
(FICO Score: 687)

Trans Union/TrueCredit (Range: 400-925)
TrueCredit: 644
(FICO Score: 688)

At first glance, the different scoring ranges might appear to be an issue, but upon further examination, Experian's scoring range is 500 points (330-830), versus 550 for Equifax/FICO (300-850) and 525 (400-925) for Trans Union. Experian's Plus Score has nearly the same range as the FICO, so it's basically a wash, and Equifax uses FICO, so range is not an issue there. The big discrepancies and problems arise with Trans Union's proprietary score. If the scoring algorithms are indeed similar, then the TrueCredit score should be around 770, not 644. The range of the TrueCredit score is 525 points, while the range of the FICO score is 550 points. Though I'm no mathematician, I simply took the 688 Trans Union FICO score and converted it to 388/550, which is 70.54 percent of the range. Using the TrueCredit range of 525, I then took the 70.54 percent of the 525 range, ending up with 370, and added it to the 400 TrueCredit floor for 770. (Although this doesn't take into consideration that the starting point is 400 for TrueCredit versus 300 for FICO, it's close enough for government work. It serves to illustrate the main point, which is that TrueCredit's score doesn't jive with FICO's at all, falling within what TrueCredit considers to be a poor range, while the FICO score for that same report falls within what FICO considers a good range.) From what I've seen based on my own observations and anecdotal evidence, it appears that TrueCredit assigns derogatory history more weight than FICO does overall, since FICO is more forgiving over time, placing more weight on recency of lateness.

Of course, this is just one set of scores, so my research method doesn't exactly qualify as scientific. On the other hand, this example is useful for demonstrating that differences can exist. Fortunately, few lenders use Trans Union's TrueCredit score. As such, don't get hung up on it. It's the FICO score that consumers should be most concerned about, since it's the one the majority of lenders look at in determining creditworthiness. Besides, if you can get your FICO score to within acceptable levels, then the other scores will likely follow suit. Gear your efforts toward FICO, and you'll come out ahead in the long run.

Credit Bureaus have their own version of a FICO score.

As an aside, the bureaus also each have a proprietary FICO score. Equifax is known as Beacon, Trans Union is known as Empirica, and Experian is known as Experian/FICO Risk Model. Of course, Equifax's Score Power is basically the same thing as a Beacon; the others are not made available to consumers, though lenders may obtain Trans Union's Empirica and the Experian/FICO Risk Model scores when they pull consolidated reports.

Lenders use the FICO score primarily as a tool for early detection of potential credit problems. By analyzing past data, they believe they can predict future results.

This has some merit, but as with all computer algorithms, the FICO score isn't without flaws. Unfortunately, that's outside your control. For now, all you can do is play along. The name of the game is improving your credit rating!

Figures 3 and 4: Copyright © 2005 Fair Isaac Corporation. Fair Isaac, the Fair Isaac logo, and the Fair Isaac product and service names are trademarks or registered trademarks of Fair Isaac Corporation.

FICO SCORING METHODOLOGY

By looking at previous credit report data and default rates based on that data, FICO believes that by matching an individual's credit report to those of other consumers with similar entries, it can more accurately predict default rates. They match people in this way and then assign them to categories. Based on the category in which the consumer is placed, he or she is then given a scorecard. Each consumer's credit history is initially assigned one of ten scorecards based on his or her worst credit entry and is sequentially passed through multiple scorecards. People who have filed for bankruptcy in the last year, for example, are assigned the worst initial scorecard, as are those with recent late payments.

This is why it's not necessarily beneficial to have all adverse entries drop off your report. Because of the way scorecards work, you may have worked your way up to the highest level within a given scorecard, and when entire tradelines fall off (due to the statute of limitations for adverse reporting, for example) you end up in a different, "better" initial scorecard, which can actually lower your score overall. That is, the lesser initial scorecard has a ceiling that goes higher than the floor of the next highest scorecard. People with a sparse credit history in particular are more susceptible to this anomaly, since the weight of a longer credit history counteracts the dropping off of an old account—one that is holding up a score because of its age. Yes, length of credit history counts substantially, which is explained shortly.¹

FICO Score Range

FICO scores range from 300 to 850, and, assuming that your total debt-to-income ratio falls within the acceptable limits (i.e., your total monthly debt, including the new loan, doesn't exceed 45 percent of your gross income), a score of 620+ will get you approved with a mainstream mortgage lender. To get the best interest rates, however, you will need a score of 720+. If your score is 780+, mortgage lenders will fight over your business, perhaps offering even better terms, such as reduced points (each point is equal to 1 percent of the total loan) or closing costs. A score of 500-619 will get you a B or C loan (alternative loan, often referred to as "subprime") with inflated interest rates and other undesirable terms, such as higher closing costs. Even if your score falls within their acceptable range, subprime mortgage lenders will usually decline you for 12 months following a bankruptcy. Add another year if you've had a foreclosure. By comparison, it takes two years to get loan approval from mainstream lenders following a bankruptcy and three years following a foreclosure.

Most mortgage lenders will pull all three credit reports and scores and then use the middle score. Some will even take the average of the top two scores and throw out the worst. Reputable auto lenders will most often take the highest FICO score, though some banks and credit unions will only pull the reports from bureaus to which they subscribe. Find out in advance of any auto loan application by checking with the dealer's finance department (or the bank or credit union if you're obtaining the loan directly).

FACTORS THAT AFFECT FICO SCORES

FICO's scoring summary (www.myfico.com) lists five categories that affect a score: payment history, amounts owed, length of credit history, types of credit used, and new credit. Each category is further broken down into subfactors, for a combined total of 22 factors. The process of generating is a score is what FICO refers to as a "multi-variant analysis." I guess this is just a fancy way of saying that multiple variables are analyzed. Here is the exact language from FICO's Web site showing how each factor is weighted:

Payment History - [35%]

• Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)

• Presence of adverse public records (bankruptcy, judgments, suits, liens, wage attachments, etc.), collection items, and/or delinquency (past-due items)

• Severity of delinquency (how long past due)

• Amount past due on delinquent accounts or collection items

• Time since (recency of) past-due items (delinquency), adverse public records (if any), or collection items (if any)

• Number of past-due items on file

• Number of accounts paid as agreed

Amounts Owed - [30%]

• Amount owing on accounts

• Amount owing on specific types of accounts

• Lack of a specific type of balance, in some cases

• Number of accounts with balances

• Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts)

• Proportion of installment loan amounts still owing (proportion of balance to original loan amount on certain types of installment loans)

Length of Credit History - [15%]

• Time since accounts opened

• Time since accounts opened, by specific type of account

• Time since account activity

New Credit - [10%]

• Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account

• Number of recent credit inquiries

• Time since recent account opening(s), by type of account

• Time since credit inquiry(s)

• Reestablishment of positive credit history following past payment problems

Types of Credit Used - [10%]

• Number of (presence, prevalence, and recent information on) various types of accounts (credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc.)

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