Personal Finance

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.

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.

Click here to order your free annual report from one or all national consumer reporting companies.

You can also purchase an annual credit report, a consumer reporting company may charge you up to
$9.50 for each copy.

To buy a copy of your report, contact:

Equifax: 800-685-1111; www.equifax.com
Experian: 888-EXPERIAN (888-397-3742); www.experian.com
TransUnion: 800-916-8800; www.transunion.com

Why is credit scoring used?

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.

What can I do to improve my score?

Credit scoring models are complex and often vary among creditors and for different types of credit. If
one factor changes, your score may change — but improvement generally depends on how that factor
relates to other factors considered by the model. Only the creditor can explain what might improve
your score under the particular model used to evaluate your credit application.

Nevertheless, scoring models generally evaluate the following types of information in your credit
report:

Have you paid your bills on time? Payment history typically is a significant factor. It is likely that
your score will be affected negatively if you have paid bills late, had an account referred to
collections, or declared bankruptcy, if that history is reflected on your credit report.

What is your outstanding debt? Many scoring models evaluate the amount of debt you have
compared to your credit limits. If the amount you owe is close to your credit limit, that is likely to have
a negative effect on your score.
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