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What is a Credit Score?

mug jerry loveThis is a question on many people’s minds. A few years ago consumers were trained to monitor their credit report. However, now consumers are seeing commercials asking, “Do you know your credit score?”

So what is a credit score? Who creates this score? And what does it mean to the consumer? There are 19 major versions of credit scoring models in use today. However, there are two major credit scoring systems. The most commonly known is the FICO Score and the other is VantageScore.

MyFICO.com gives us the background and foundation for the FICO Score:

“90% of top lenders use FICO Scores to help them make billions of credit-related decisions every year. FICO Scores are calculated based solely on information in consumer credit reports maintained at the credit reporting agencies.

“By comparing this information to the patterns in hundreds of thousands of past credit reports, FICO Scores estimate your level of future credit risk.”

Bankrate.com elaborates more on the FICO Score:

“Technically, it’s a predictive analytics company founded in 1956. But, generally, when people hear “FICO,” they’re thinking of the scores it gives -- three-digit numbers introduced in 1989 that essentially determine “the likelihood that you will pay all of your (debt) obligations on time for the foreseeable future,” says Barry Paperno, former consumer affairs manager for FICO who now runs the blog SpeakingOfCredit.com.

“The first FICO scores, and their descendants, predicted the likelihood a consumer will become 90 days behind on payments over the next 24 months on different debt types. Over the years, the score has been poked, prodded and tweaked from its original formula to account for changes in consumer behavior and the lending landscape, says Frederic Huynh, senior principal scientist at FICO.”

Credit.com gives us an excellent overview of VantageScore:

“VantageScore first exploded on the credit score scene in 2006 as a joint venture of the big three credit bureaus – Experian, Equifax and TransUnion.

“Like other credit scores, VantageScore consists of calculations relying entirely on credit bureau information – not income, bank accounts or other assets – to predict how likely you are to pay your credit obligations on time each month. With an emphasis on paying on time, keeping balances low, and avoiding new credit obligations, the simplicity and common-sensibility of credit scores are often marred by the all-too-frequent credit reporting errors that can lead to credit scoring errors, and that can require active management of your credit – much like managing your health.”

CreditKarma.com gives us some context on the evolution of the credit scoring system:

“Prior to the creation of standardized credit scores, lenders and loan officers would often develop their own “score card” to assess the risk of lending to a particular borrower. This score card could vary drastically from one lender to the next. The major issue with this original method was that it was based on a loan officer’s ability to judge risk, rather than a common set of rules and specific calculations.

“So, in the 1980’s, the Fair Isaac Corporation set up the first general purpose credit scoring system based on credit bureau information in order to help remove the inherent inconsistencies that arose from having each lender perform their own credit diagnostics.”

Bankrate.com explains this for us:

“Your credit score is a three-digit number generated by a mathematical algorithm using information in your credit report. It’s designed to predict risk, specifically, the likelihood that you will become seriously delinquent on your credit obligations in the 24 months after scoring.

The Consumer Financial Protection Bureau indicates the most common factors used for the credit score are 1) your most recent credit activity, 2) how long you have had your accounts open and 3) whether you had any debts referred for collection, foreclosure or bankruptcy. However, perhaps even more importantly the Equal Credit Opportunity Act (ECOA) prohibits the use of certain items for use in the calculation of your score. These are: 1) Race or color, 2) Religion, 3) Sex (gender), 4) National origin, 5) Marital Status and 6) whether you have formally disputed information contained on your credit report.

Overall the factors align in five broad categories: 1) 30% is amount you owe, 2) 35% is payment history, 3) 15% is length of credit history, 4) 10% is new credit and 5) 10% is credit mix. Some of the items used to calculate your credit score are:

• Payment History
• How long your accounts have been open and available foryou? Generally, more is better. • How long it has been since you used certain accounts?
• How long specific credit accounts have been established?
• What percentage of your available credit are you currently using?
• How many accounts are listed on your credit report?
• The age of your oldest account, the age of your newest account and an average age of all your accounts.
• The mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.
• The derogatory marks such as accounts sent to collections, bankruptcies, civil judgements or tax liens.
• How many new accounts have you recently opened? • How many hard credit inquiries are shown on your credit report?

Where does this information come from? Your credit score is calculated from information contained on your credit report. For this reason, Bankrate.com confirms for us:

“A consumer has three FICO scores, one for each credit report provided by the three major credit bureaus: Equifax, Experian and TransUnion. Unfortunately, consumers currently have access to only their Equifax and TransUnion FICO scores. Experian ended its agreement with myFICO.com in 2009.”

A FICO score will range between 300 and 850. The higher the score, the better. The Federal Trade Commission gives us the following guidance for how to improve our credit score:

“Credit scoring systems are complex and vary among creditors or insurance companies and for different types of credit or insurance. If one factor changes, your score may change — but improvement generally depends on how that factor relates to others the system considers. Only the business using the system knows what might improve your score under the particular model they use to evaluate your application.”

Nevertheless, scoring models usually consider the following types of information in your credit report to help compute your credit score:

Have you paid your bills on time? You can count on payment history to be a significant factor. If your credit report indicates you have paid bills late, had an account referred to collections, or declared bankruptcy, it is likely to affect your score negatively.

Are you maxed out? Many scoring systems evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, it’s likely to have a negative effect on your score.

How long have you had credit? Generally, scoring systems consider your credit track record. An insufficient credit history may affect your score negatively, but factors like timely payments and low balances can offset that.

Have you applied for new credit lately? Many scoring systems consider whether you have applied for credit recently by looking at “inquiries” on your credit report. If you have applied for too many new accounts recently, it could have a negative effect on your score. Every inquiry isn’t counted: for example, inquiries by creditors who are monitoring your account or looking at credit reports to make “prescreened” credit offers are not considered liabilities.

How many credit accounts do you have and what kinds of accounts are they? Although it is generally considered a plus to have established credit accounts, too many credit card accounts may have a negative effect on your score. In addition, many scoring systems consider the type of credit accounts you have. For example, under some scoring models, loans from finance companies may have a negative effect on your credit score.

Scoring models may be based on more than the information in your credit report. When you are applying for a mortgage loan, for example, the system may consider the amount of your down payment, your total debt, and your income, among other things.

Improving your score significantly is likely to take some time, but it can be done. To improve your credit score under most systems, focus on paying your bills in a timely way, paying down any outstanding balances, and staying away from new debt.”

On June 26, 2016, LaToya Irby published an article entitled 10 Things You Can Do Today to Improve Your Credit Score.

1. Get a copy of your credit reports.
2. Dispute a credit report error.
3. Avoid new credit card purchases.
4. Pay off a past due balance.
5. Avoid a new credit card application.
6. Leave accounts open, especially those with balances.
7. Make contact with your creditors.
8. Pay off debt.
9. Get professional help.
10. Be patient and persistent.

The full article can be read at http://credit.about.com/od/creditrepair/tp/improvecredit.htm

On June 28, 2016 LaToya Irby followed this article with an article titled Nine Things That Boost Your Credit Score.

http://credit.about.com/od/creditrepair/tp/Things-That-Boost-Your-Credit-Score.htm

Both of these articles give you practical, straight-forward suggestions on this question which seems to be on many people’s mind.

This list of four items By Christine Digangi of Credit.com was published by ABC.com March 26, 2014 4 (Perfectly Legal) Hacks to Improve Your Credit Score

1. Use a Buddy System
2. Pay Often
3. Strategically Open Accounts
4. A Card Lost

The full article can be found at http://abcnews.go.com/Business/perfectly-legal-hacks-improve-credit-score/story?id=23071180

Without a doubt, there is a much higher awareness of our credit scores these days. Offer clients a better understanding of what the credit score is, how it is calculated and provides some practical suggestions for improving their scores, if needed.


Jerry Love is the sole owner of Jerry Love CPA, LLC in Abilene, Texas. Love graduated from Abilene Christian University. In addition to being a CPA, Love has also earned the designations of PFS, CFP, CVA, ABV, CITP, CFF, and CFFA. In 2006-07, Love was the Chairman of the Texas Society of CPAs.