Unless someone's independently wealthy, a credit score is and important number and can determine their financial wellbeing. Scores are used by both lenders and creditors to predict if an individual is going to pay their bills in a timely manner; thereby influencing decisions to extend credit or approve a loan.
In this article, we're going to provide information on the credit reporting and scoring process. That discussion will also include information about credit rating agencies, and how these agencies go about calculating a score.
We're also going to help answer the question: "What is a good credit score?" We'll do this by providing statistics and trends on a national basis. Finally, we're going to provide insights into the ways consumers can improve their score.
Credit rating agencies, or credit bureaus, calculate scores based on historical payment patterns. Payments include monthly bills such as credit card and utility bills as well as loans. Much of the information used to calculate a credit score is found in a credit report. That's good news, because as a result of the Fair Credit Reporting Act, everyone is entitled to a free credit report annually.
While the accuracy of the information contained in a report is extremely important to understand, a score is not typically contained in this document. In fact, consumers are not entitled to receive a free credit score, only their report. Consumers wishing to obtain their scores will have to pay one of the credit agencies a nominal fee of around $15.
The most common score used by lenders and creditors today is the FICO® score developed by Fair Isaac. Each of the three credit bureaus calculates their own proprietary version of the FICO score. Those scores are sold to lenders and creditors that want to understand the risk of nonpayment they are taking before deciding to lend someone money or waive a deposit.
The names used by each of the credit bureaus include:
|Credit Bureau||FICO Score|
|Experian||Experian / Fair Isaac Risk Model|
A consumer's score is calculated separately by each of the three credit rating agencies based on information reported to them by utilities, credit card issuers, phone companies, and other creditors and lenders. The components used in the calculation of a FICO score includes:
FICO scores are on a scale of 300 to 850. The table below shows the national distribution of these scores as of April 2018, published in August 2018.
|800 - 850||21.8%||21.8%|
|750 - 799||20.2%||42.0%|
|700 - 749||16.2%||58.2%|
|650 - 699||13.0%||71.2%|
|600 - 649||9.6%||80.8%|
|550 - 599||8.1%||88.9%|
|500 - 549||6.8%||95.7%|
|300 - 499||4.2%||99.9%|
The information in the above table is interpreted in this manner. Approximately 22% of the U.S. population has a FICO score of 800 or higher, while 58% of the population has a score of 700 or higher. The average FICO Score in 2019 was 703.
Lenders consider individuals with FICO scores above 700 as being in good financial health. On the other hand, individuals with scores below 600 may be viewed as high risk, and may even be turned downed for credit or charged a higher interest rate on a loan.
This new score was developed by all three credit rating agencies, Experian, Equifax and TransUnion. The VantageScore allows for better scoring of "thin file" consumers, which are individuals with a limited credit history. The calculated value for a consumer is also expected to be more consistent between agencies.
Under the VantageScore system, credit scores will range from 501 to 990. As is the case with FICO scores, consumers with higher values are thought to carry a lower risk of default, and should be offered more attractive interest rates on loans. To help differentiate between good and bad scores, VantageScores were also put on an academic scale as shown below:
While the scale seems to be linear, the risk of default is not. Using data published by TransUnion, a graph was constructed demonstrating how risk of default grows significantly as credit scores decrease.
The national average credit score under the VantageScore system is 673 (as of October 2017). As the above letter assignment indicates, the national average would grade out as a "C." Using the equation developed when producing the chart above, the average risk of default is 1.9% at 750. While that value might seem small, it's ten times the risk of a consumer with a score of 900.
The table below shows the national distribution of credit scores using the VantageScore system.
|900 - 990||A||14%||14%|
|800 - 899||B||25%||39%|
|700 - 799||C||21%||60%|
|600 - 699||D||20%||80%|
|550 - 599||F||10%||90%|
|501 - 549||F||9%||99%|
Note: While the above scores are still used by companies such as TransUnion, VantageScore 3.0, is now on a scale that ranges from 300 to 850.
There are a total of five factors that go into the calculation of a VantageScore:
The graph below shows a side-by-side comparison of the factors used in FICO versus VantageScore as well as their weights.
We're going to finish up by talking about ways to improve a credit score. Individuals that had trouble paying bills in the past, or would like to increase their score can take the following steps:
There is only one legitimate action an individual can take to repair their credit score: Get a free online credit report, and make sure it's accurate.
Individuals with poor credit scores oftentimes look to companies offering repair services for help. It's important to understand the only legal way to increase a score is by the means mentioned above, fixing mistakes appearing on a report.
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