Credit Scoring

Ever wonder how a creditor decides whether to grant you credit? For years, creditors have been using credit scoring systems to determine if you’d be a good risk for credit cards and auto loans.

More recently, credit scoring has been used to help creditors evaluate your ability to repay home mortgage loans. Here’s how credit scoring works in helping decide who gets credit — and why.

What is credit scoring?

Credit scoring is a system creditors use to help determine whether to give you credit.

Information about you and your credit experiences, such as your bill-paying history, the number and type of accounts you have, late payments, collection actions, outstanding debt, and the age of your accounts, is collected from your credit application and your credit report. Using a statistical program, creditors compare this information to the credit performance of consumers with similar profiles.

A credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points — a credit score — helps predict how creditworthy you are, that is, how likely it is that you will repay a loan and make the payments when due.

Because your credit report is an important part of many credit scoring systems, it is very important to make sure it’s accurate before you submit a credit application. An amendment to the federal Fair Credit Reporting Act (FCRA) requires each of the major nationwide consumer reporting companies to provide you with a free copy of your credit reports, at your request, once every 12 months.

Free reports have been phased in during a nine-month period, starting with the states in the West and ending with states in the East. Beginning September 1, 2005, free reports will be accessible to all Americans, regardless of where they live.

To order your free annual report from one or all national consumer reporting companies, visit www.annualcreditreport.com, call toll-free 877-322-8228, or complete the Annual Credit Report Request Form and mail it to: Annual Credit Report Request Service, P. O. Box 105281, Atlanta, GA 30348-5281. The form is at the back of this brochure; or you can print it from ftc.gov/credit. Do not contact the three nationwide consumer reporting companies individually. They provide free annual credit reports only through 877-322-8228, www.annualcreditreport.com, and Annual Credit Report Request Service, P. O. Box 105281, Atlanta, GA 30348-5281.

If you’re not yet eligible for a free annual credit report, a consumer reporting company may charge you up to $9.50 for each copy.

For more information, see Your Access to Free Credit Reports at ftc.gov/credit.

Credit scoring is based on real data and statistics, so it usually is more reliable than subjective or judgmental methods. It treats all applicants objectively. Judgmental methods typically rely on criteria that are not systematically tested and can vary when applied by different individuals.

How is a credit scoring model developed?

To develop a model, a creditor selects a random sample of its customers, or a sample of similar customers if their sample is not large enough, and analyzes it statistically to identify characteristics that relate to creditworthiness. Then, each of these factors is assigned a weight based on how strong a predictor it is of who would be a good credit risk. Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.

Under the Equal Credit Opportunity Act (ECOA), a credit scoring system may not use certain characteristics -- like race, sex, marital status, national origin, or religion — as factors. However, creditors are allowed to use age in properly designed scoring systems. But any scoring system that includes age must give equal treatment to elderly applicants.