Credit score in the United States

Credit scores in the United States are numbers that represent the creditworthiness of a person, the likelihood that person will pay their debts.

Lenders, such as banks and credit card companies, use credit scores to evaluate the risk of lending money to consumers. Lenders allege that widespread use of credit scores has made credit more widely available and less expensive for many consumers.[1][2] Under the Wall Street reform bill passed in 2010, a consumer is entitled to receive a free credit score if they are denied a loan, credit card or insurance due to their credit score.[3]

Credit scoring models

FICO score

The FICO score was first introduced in 1989 by FICO, then called Fair, Isaac, and Company.[4] The FICO model is used by the vast majority of banks and credit grantors, and is based on consumer credit files of the three national credit bureaus: Experian, Equifax, and TransUnion. Because a consumer's credit file may contain different information at each of the bureaus, FICO scores can vary depending on which bureau provides the information to FICO to generate the score.

Makeup


Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulas for calculating credit scores are secret, FICO has disclosed the following components:[5][6]

  • Payment history (35%): Best described as the presence or lack of derogatory information. Bankruptcy, liens, judgments, settlements, charge offs, repossessions, foreclosures, and late payments can cause a FICO score to drop.
  • Debt burden (30%): This category considers a number of debt specific measurements. According to FICO there are six different metrics in the debt category including the debt to limit ratio, number of accounts with balances, the amount owed across different types of accounts, and the amount paid down on installment loans.[7]
  • Length of credit history or "time in file" (15%): As a credit history ages it can have a positive impact on its FICO score. There are two metrics in this category: the average age of the accounts on a report and the age of the oldest account.
  • Types of credit used (10%): Consumers can benefit by having a history of managing different types of credit. Examples of types of credit include installment, revolving, consumer finance, and mortgage.[8]
  • Recent searches for credit (10%): hard credit inquiries or "hard pulls", which occur when consumers apply for a credit card or loan (revolving or otherwise), can hurt scores, especially if done in great numbers. Individuals who are "rate shopping" for a mortgage, auto loan, or student loan over a short period (two weeks or 45 days, depending on the generation of FICO score used) will likely not experience a meaningful decrease in their scores as a result of these types of inquiries, as the FICO scoring model considers all of those types of hard inquiries that occur within 14 or 45 days of each other as only one. Further, mortgage, auto, and student loan inquiries do not count at all in a FICO score if they are less than 30 days old. While all credit inquiries are recorded and displayed on personal credit reports for two years, they have no effect after the first year because FICO's scoring system ignores them after 12 months. Credit inquiries that were made by the consumer (such as pulling a credit report for personal use), by an employer (for employee verification), or by companies initiating pre-screened offers of credit or insurance do not have any impact on a credit score: these are called "soft inquiries" or "soft pulls", and do not appear on a credit report used by lenders, only on personal reports. Soft inquires are not considered by credit scoring systems.[9]

These percentages are based on the importance of the five categories for the general population. For particular groups—for example, people who have not been using credit long—the relative importance of these categories may be different.[5]

The makeup factors are limited to the individual's past (and continuing) behavior on credit. Contrary to common misconception,[10] other financial factors such as age, employment status, asset, income, etc. are not accounted. It, however, does not prevent lenders from asking and accounting these factors for particular lending considerations.

Getting a higher credit limit can help a credit score. The higher the credit limit on the credit card, the lower the utilization ratio average for all of a borrower's credit card accounts. The utilization ratio is the amount owed divided by the amount extended by the creditor and the lower it is the better a FICO rating, in general. So if a person has one credit card with a used balance of $500 and a limit of $1,000 as well as another with a used balance of $700 and $2,000 limit, the average ratio is 40 percent ($1,200 total used divided by $3,000 total limits). If the first credit card company raises the limit to $2,000, the ratio lowers to 30 percent, which could boost the FICO rating.

There are other special factors that can weigh on the FICO score.

  • Any money owed because of a court judgment, tax lien, etc., carries an additional negative penalty, especially when recent.
  • Having one or more newly opened consumer finance credit accounts may also be a negative.[11]

Ranges

There are several types of FICO credit score: classic or generic or general-purpose score, industry-specific scores (bankcard score, auto score, mortgage score, personal finance score, and installment loan score), XD score, NextGen risk score, and UltraFICO score. The classic FICO credit score (named FICO credit score) is between 300 and 850, and 59% of people had between 700 and 850, 45% had between 740 and 850, and 1.2% of Americans held a perfect FICO score (850) in 2019.[12][13] According to FICO, the median FICO credit score in 2006 was 723 and 711 in 2011.[14] The average FICO Score 8 in the U.S. was 703 in 2019.[15] The FICO bankcard score, FICO auto score, FICO personal finance score, and FICO installment loan score are between 250 and 900. The FICO mortgage score and FICO score XD 2 are between 300 and 850. Higher scores indicate lower credit risk.[16] Experian classifies the FICO credit score lower than 580 as very poor, 580–669 as fair, 670–739 as good, 740–799 as very good, and 800–850 as exceptional.[17] Equifax considers the FICO score lower than 580 as poor, 580-669 is fair, 670-739 is good, 740-799 is very good, and 800-850 is excellent. The individuals with a FICO score below 670 are seen as subprime borrowers.[18]

Each individual actually has over 60 credit scores for the FICO scoring model because each of three national credit bureaus, Equifax, Experian and TransUnion, has its own database. Data about an individual consumer can vary from bureau to bureau.[18] FICO scores have different names at each of the different credit reporting agencies: Equifax (Beacon), TransUnion (FICO Risk Score, Classic) and Experian (Experian/FICO Risk Model). There are five active generations of FICO credit scores: FICO 98 (1998), FICO 04 (2004), FICO 8 (2009), FICO 9 (2014), FICO 10 and FICO 10 T (2020).[19][20][21] A new type of FICO score named UltraFICO score was released in 2019.[22] The FICO 95 credit score released in 1995 and Equifax FICO 98 scores are no longer in use. The Experian FICO 98 score is named FICO Score 2, Experian FICO 04 score is FICO Score 3, TransUnion FICO 04 score is FICO Score 4, and Equifax FICO 04 score is FICO Score 5. The FICO Score XD is made with alternative data of the people, and was released in 2016. Consumers can buy their FICO Score 8 for Equifax, TransUnion, and Experian from the FICO website (myFICO), and they will get some free FICO scores in that moment: FICO Bankcard Score 8, FICO Auto Score 8, FICO Score 9, FICO Auto Score 9, FICO Bankcard Score 9, and other FICO scores (1998 and 2004 versions). Consumers also can buy their FICO Score 5 (classic version of 2004) for Equifax in the website of this credit bureau, and their FICO Score 8 for Experian on its website. Other types of FICO scores cannot be obtained by individuals, only by lenders.[23] Some credit cards offer a free FICO score (classic, bankcard or NextGen) several times per year to their cardholders.

FICO NextGen Risk Score

The FICO NextGen Risk Score is a scoring model designed by the FICO company for assessing consumer credit risk. This score was introduced in 2001 (FICO score NG1), and in 2003 (FICO score NG2) the second generation of NextGen was released.[24] In 2004, FICO research showed a 4.4% increase in the number of accounts above cutoff while simultaneously showing a decrease in the number of bad, charge-off and Bankrupt accounts when compared to FICO traditional.[25] FICO NextGen score is between 150 and 950.

Each of the major credit agencies markets this score generated with their data differently:

  • Experian: FICO Advanced Risk Score
  • Equifax: Pinnacle
  • TransUnion: FICO Risk Score NextGen

FICO SBSS

The FICO Small Business Scoring Service (SBSS) score is used to evaluate small business credit applicants.[26] This score can evaluate the personal credit report of a business owner along with the business credit report of the business itself. Financial information of the business may be evaluated as well. The score range for the FICO SBSS score is 0–300. A higher score indicates less risk. Applications for SBA 7(a) loans for $350,000 or less will be prescreened using this score. A minimum score of 140 is needed to pass this prescreen, though most lenders require scores of 160 or more.

VantageScore

In 2006, to try to win business from FICO, the three major credit-reporting agencies introduced VantageScore credit score, which differs from FICO in several ways. According to court documents filed in the FICO v. VantageScore federal lawsuit,[27] the VantageScore market share was less than 6% in 2006. The VantageScore methodology initially produced a score range from 501 to 990 (VantageScore 1.0 score and VantageScore 2.0 score), but VantageScore 3.0 score adopted the score range of 300–850 in 2013.[28] The VantageScore 4.0 score was released in mid-2017 and also uses a range of 300–850. Consumers can get free VantageScores from free credit report websites, and from some credit cards issued by Capital One, U.S. Bank, Chase Bank, TD Bank, N.A., Synchrony Bank, and USAA Bank. The VantageScore score (3.0 and 4.0) lower than 550 is very poor, 550–649 is poor, 650–699 is fair, 700–749 is good, and 750–850 is excellent.[29][30]

CE Score

CE Score is published by CE Analytics. This score is distributed to 6,500 lenders through the Credit Plus network. It has a range of 350 to 850.[31]

Educational credit scores

A number of scores have been developed to help consumers understand and improve their credit scores. Most were introduced before FICO began sharing details of their model and encouraging lenders to share scores with consumers. While these scores can help consumers monitor and improve their score, these scores do not replicate the FICO score and may be substantially less accurate if they use less complete data. They also assign different score ranges and rankings to consumers, which has created confusion among consumers who expect to have a single score number. Discussions on the myFICO forum and elsewhere have referred to non-FICO scores as FAKO scores.[32]

Experian has the Plus Score between 330 and 830, and Experian's National Equivalence Score ranges from 360 to 840. Equifax has the Equifax Credit Score of between 280 and 850. TransUnion New Account Score 3.0 (formerly TransRisk score) is between 150 and 950. CreditXpert offers a simulation score to estimate the impact of various actions on a score range of 350 to 850.

Other credit scores

Lenders may choose to use non-FICO credit scores to gain additional insight on consumers, especially those with limited traditional credit history who might be difficult to score. These scores may be added to the FICO score if they provide unique insights or used instead of the FICO score if they provide similar predictiveness. Most of these scores are based significantly on data not available through the national credit bureaus (alternative data), such as rental, utility, and telecom payment data or public record information such as property deeds and mortgages, liens, personal property titles, tax records, and licensing data.

The Credit Optics Score by SageStream blends traditional and alternative credit data with machine learning modeling techniques and ranges from 1 to 999. LexisNexis RiskView score, based on wide-ranging public records, ranges from 501 to 900. CoreLogic Credco reports on property related public records and its Anthem Credit Score ranges from 325 to 850. PRBC allows consumers to self-enroll and report their own non-debt payment history. The PRBC alternative credit score range is 100 to 850. There are also scores like ChexSystems Consumer Score designed for financial account verification services ranging from 100 to 899. The L2C (Link2Credit) score by L2C, Inc. ranges from 300 to 850. Scorelogix LLC offers the JSS Credit Score, which assesses credit risk based on job history, income, and the impact of the economy. A Behavioral Risk Score (0 to 999) is used by Comenity Bank and Comenity Capital Bank.

Free annual credit report

As a result of the FACT Act (Fair and Accurate Credit Transactions Act), each legal U.S. resident is entitled to a free copy of his or her credit report from each credit reporting agency once every twelve months.[33] The law requires all three agencies, Equifax, Experian, and Transunion, to provide reports. These credit reports do not contain credit scores from any of the three agencies. The three credit bureaus run Annualcreditreport.com, where users can get their free credit reports. Non-FICO credit scores are available as an add-on feature of the report for a fee. This fee is usually $7.95, as the FTC regulates this charge through the Fair Credit Reporting Act.[34]

Non-traditional uses of credit scores
Main article: Insurance score

Credit scores are often used in determining prices for auto and homeowner's insurance. Starting in the 1990s, the national credit reporting agencies that generate credit scores have also been generating more specialized insurance scores, which insurance companies then use to rate the insurance risk of potential customers.[35][36] Studies indicate that the majority of those who are insured pay less in insurance through the use of scores.[37][38] These studies point out that people with higher scores have fewer claims.

In 2009, TransUnion representatives testified before the Connecticut legislature about their practice of marketing credit score reports to employers for use in the hiring process. Legislators in at least twelve states introduced bills, and three states have passed laws, to limit the use of credit check during the hiring process.[39]

Criticism

Discriminatory effects

Credit scores are widely used as the basis for decisions to allow or deny individuals the opportunity to do things like taking out loans, buy houses and cars, and open credit cards and other kinds of accounts. This has been criticized as a practice having discriminatory effects.[40] Credit companies purport to measure creditworthiness by looking at information like the number of accounts held, length of credit, history of paying back borrowed money, and punctuality of payment. As credit scores have become necessary to maintain credit and purchasing power, this system has come to serve as a wall between favored and disfavored classes of people.[41] [42][43][44]

Easily gamed

Because a significant portion of the FICO score is determined by the ratio of credit used to credit available on credit card accounts, one way to increase the score is to increase the credit limits on one's credit card accounts.[45]

Not a good predictor of risk

Credit scores are enhanced by having multiple credit cards, the use of credit cards, and having installment loans. However, financially secure individuals who do not use multiple credit cards, or who self-finance expenses, may be inaccurately assessed a lower credit score.[46]

Some have blamed lenders for inappropriately approving loans for subprime applicants, despite signs that people with poor scores were at high risk for not repaying the loan. By not considering whether the person could afford the payments if they were to increase in the future, many of these loans may have put the borrowers at risk of default.[47]

Some banks have reduced their reliance on FICO scoring. For example, Golden West Financial abandoned FICO scores for a more costly analysis of a potential borrower's assets and employment before giving a loan.[48]

Use in employment decisions

Experian, Equifax, TransUnion and their trade association the Consumer Data Industry Association have all stated that employers do not receive credit scores on the credit reports sold for the purposes of employment screening. Credit reports are legal to use for employment screening in all states, although some have passed legislation limiting the practice to only certain positions. Eric Rosenberg, director of state government relations for TransUnion, has also stated that there is no research that shows any statistical correlation between what's in somebody's credit report and their job performance or their likelihood to commit fraud.[49]

Other concerns

The use of credit information in connection with applying for various types of insurance or in landlord background checks has drawn similar amounts of scrutiny and criticism, because obtaining and maintaining employment, housing, transport, and insurance are among the basic functions of meaningful participation in modern society, and in some cases (such as auto insurance) are mandated by law.[50]

Credit scores and morality

Credit scores have been widely criticized as a systematic way to measure morality. They track consumption choices over time and so they are used to reflect a person's ability to manage money. The classification system of credit scores "rewards consumers who belong to the right category", and excludes those who are on the fringes of classification; credit scores nominally intended as a gauge of reliability as a lender becomes instead a gauge of morality. Companies keep records of purchasing behavior, which suggests certain behavior patterns, some of which are rewarded and others are punished—usually in ways that broaden the economic and (perceived) moral gaps between richer and poorer persons. These punishments can include higher premiums, loss of privileges, poorer service, or higher interest rates, which ultimately affect credit score and purchasing power.[44]

See also

References
  1. Report to the Congress on credit scoring and its effects on the availability and affordability of credit
  2. An overview of consumer data and credit reporting
  3. http://www.whitehouse.gov/blog/2010/07/15/president-obama-final-passage-wall-street-reform-end-bailouts-a-beginning-accountabi.
  4. "Our History". FICO.
  5. "How Are Credit Scores Calculated? Learn What Affects Your Credit Score". myFICO.com. Retrieved 2010-01-19.
  6. Dayana Yochim. "How Lenders Keep Score". TheMotleyFool. Archived from the original on 2008-03-15. Retrieved 2008-02-29.
  7. "Amounts Owed – How It Impacts Your Score". Archived from the original on 2016-10-17. Retrieved 23 October 2016.
  8. Is Paying Off the Mortgage Good for Our Credit? Credit Cards Q&A By Joan Goldwasser, Kiplinger Personal Finance magazine, October 2008
  9. "What are inquiries and how do they affect my FICO score?". myFICO.
  10. "Consumer Watch". okcfox.com.
  11. "Hold Off on Opening New Credit Cards" 12–09–07 Archived 2011-06-29 at the Wayback Machine
  12. http://www.experian.com/blogs/ask-experian/consumer-credit-review/
  13. Credit Score Information: About FICO Scores – myFICO.com
  14. "New Mortgages Worry Regulators" The Washington Post, June 10, 2006
  15. http://www.experian.com/blogs/ask-experian/what-is-the-average-credit-score-in-the-u-s/.
  16. "What Is the Range for Credit Scores?" NerdWallet, October 28, 2016
  17. http://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-is-a-good-credit-score/.
  18. http://www.equifax.com/personal/education/credit/score/what-is-a-good-credit-score/
  19. http://www.myfico.com/credit-education/credit-scores/new-fico-scores.
  20. http://www.fico.com/en/resource-download-file/13871.
  21. http://www.marketwatch.com/story/fico-just-updated-its-scores-heres-what-you-need-to-know-2020-01-24
  22. http://www.fico.com/en/newsroom/experian-fico-and-finicity-launch-new-ultrafico-credit-score
  23. http://www.fico.com/en/newsroom/fico-now-offers-consumers-access-to-19-versions-of-the-fico-score-used-most-frequently-by-lenders-for-mortgages-auto-loans-credit-cards-03-31-2015.
  24. "FICO® NextGen Risk Scores" (PDF). Archived from the original (PDF) on 2016-12-21. Retrieved 2016-01-05.
  25. "FICO NextGen Score". FICO. Archived from the original on 2010-08-20.
  26. "FICO® Small Business Scoring Service". FICO® | Decisions. Retrieved 2017-04-10.
  27. Fair Isaac Corporation v. Experian Information Solutions (United States Court of Appeals for the Eighth Circuit August 17, 2011).No. 10-2409
  28. "VantageScore". VantageScore.com. Retrieved 2010-01-19.
  29. http://experian.com/blogs/ask-experian/what-is-a-vantagescore-credit-score/
  30. Harzog, Beverly (November 20, 2019). "What Is a Fair Credit Score?". U.S. News & World Report. Archived from the original on 2019-11-21. Retrieved September 3, 2020.
  31. "How to get a free credit score". Bankrate.com. Retrieved 2011-06-26.
  32. "Official credit score will cost you, but fake one won't". Grand Forks Herald. April 6, 2010. Retrieved November 15, 2020. ... you can get a free 'FAKO' score. These fake FICO scores come from credit-score simulators or off-brand scoring models
  33. "Home Page". Annual Credit Report.com. Retrieved 23 October 2016.
  34. "Fair Credit Reporting Act".
  35. Credit-based insurance scores: Impacts on consumers of automobile insurance Archived 2009-05-11 at the Wayback Machine A Report to Congress by the Federal Trade Commission July 2007
  36. No evidence of disparate impact in Texas due to use of credit information by personal lines insurers Dr. Robert P. Hartwig in January 2005. Insurance Information Institute
  37. Allstate Insurance Company’s additional written testimony July 23, 2002
  38. Use and impact of credit in personal lines insurance premiums pursuant to Ark. Code Ann. §23-67-415 Archived 2009-05-21 at the Wayback Machine (September 1, 2006) – A report to the legislative council and the Senate and House committees on insurance and commerce of the Arkansas General Assembly (as required by Act 1452 of 2003)
  39. "As a Hiring Filter, Credit Checks Draw Questions", The New York Times, April 9, 2010
  40. [Rice, L and Swesnik, D: "Discriminatory Effects of Credit Scoring on Communities of Color" Suffolk University Law Review 46:935 (2013)]
  41. Credit scores in America perpetuate racial injustice. Here's how
  42. Credit Scores Could Soon Get Even Creepier and More Biased
  43. How Algorithms Can Bring Down Minorities' Credit Scores
  44. Fourcade, Healy, Marion, Kieran (2013). "Classification situations: Life-chances in the neoliberal era". Accounting, Organizations and Society. 38 – via Elsevier.
  45. "Credit Scores: Not-So-Magic Numbers" Business Week, Feb. 7, 2008.
  46. "How Payment History Impacts Your Credit Score – myFICO". www.myfico.com.
  47. Credit scores didn't fail in screening applicants for subprime loans Archived 2011-07-23 at the Wayback Machine(April 7, 2008)By PAMELA YIP / The Dallas Morning News
  48. "Credit Scores: Not-So-Magic Numbers" Business Week, Feb. 7, 2008. Archived 2009-01-23 at the Wayback Machine
  49. "Millions Need Not Apply" New York Times, May 29, 2011.
  50. Legislatures, National Conference of State. "Use of Credit Information in Insurance 2011 Legislation". Retrieved 23 October 2016.
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