Consumer Credit Scoring Models

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Why Consumers Have So Many Credit Scores

Consumer Credit Scores

Before the use of credit scores, lenders used data from credit reports, individual account information, consumer financials, and their own underwriter’s judgement when vetting loan applicants. As one can imagine, this quickly became a risky venture for banks since they began to face many discrimination lawsuits.

In response to the need for a measurement of risk that was non biased and separate from the bank, in 1950’s FICO (then called Fair Isaac and Company), developed the first credit score but it took over 20 more years to create a successful credit scoring model using data from the three major Credit Reporting Agencies (CRA).

Today the majority of FICO scores range from 300 to 850, and there are over 50 different FICO credit score versions depending on the lenders needs for analyzing risk.  There are FICO scores used by auto lenders, credit card issuers, mortgage lenders, and more.  The CRAs do offer their own separate scores but FICO remains the most popular among lenders.

The three major CRAs include Experian, Trans Union, and Equifax, they gather and process information on hundreds-of-millions of American businesses and consumers. The CRAs collect both public record information and consumer data on credit usage and payment habits/trends. This data is listed in credit reports and is used to generate a credit score.

Information on credit scoring is more widely available.

Even though the exact algorithm that the CRAs and FICO use to generate scores is a well-kept secret, over the years more information has become available to consumers looking to better manage their credit.

For instance, we know certain factors impact credit scores:

  • Balance to limit ratios
  • Types of credit
  • Payment history
  • Credit history
  • New credit

The Consumer Financial Protection Bureau (CFPB) and federal regulations have pushed for more credit information being made available over the last decade. These regulatory moves have been created to motivate FICO and the CRAs to be more transparent by communicating with consumers so they can better understand and utilize their credit.

With the spread of knowledge there can be more awareness and active consumers who better understand how their creditworthiness can impact their future. But the vast amount of information can be confusing and since there are at least hundreds of credit scores that can be purchased online, consumers often buy a credit score and find out it is not the score used by the type lender or loan they are going for.  This can be very frustrating when a borrower finds out a few days before applying for a mortgage that they were looking at a credit card FICO score.  Now they come to learn their FICO mortgage score is 40 points lower and the rate being offered is much higher.  This is why knowing what score you are being judged by is most important well before you are making the application.

In most cases the creditor/lender picks the scoring model they will use when deciding risk.

Unless the mortgage or loan is backed/insured by the government, each lender has the right to pick which specific FICO® scores must be used.

Each consumer credit bureau may have different information which is why each credit bureau may have a different score: TransUnion FICO® scores, Experian FICO® scores, and Equifax FICO® scores. When shopping for a mortgage, lenders normally take the middle number of the three FICO® scores and that is what will be used to assess risk on a mortgage applicant.

We speak to clients everyday who are unaware of the differences in credit rating models and FICO score versions.

Here are a few scoring models you’re likely familiar with:

  1. FICO® Scores – FICO specializes in creating scoring systems and have the most widely used scoring models, there are over 50 FICO credit scores for each individual. For instance, if you’re looking to open a credit card most likely the creditor will review your FICO Credit Card Scores or if you’re looking for a mortgage your middle FICO Mortgage Credit Score will be analyzed. Each FICO score is customized based on the type of credit you’re looking for.
  2. Vantage – Developed in 2006, the purpose was to provide a consistent score based on data collected by all three major CRAs. Some lenders do use your Vantage Score, although it is not as widely popular as FICO scores.
  3. PLUS scores – Educational score created for consumers who were looking to learn more about their credit. Lenders do not use PLUS Scores when accessing risk.
  4. Credit Karma – The free credit scores from Credit Karma are your Vantage score from TransUnion and Equifax. This is more of an educational score and is often inflated from the score that a lender will see.
  5. Credit Card Scores – Nearly every credit card provider has begun offering “Free Credit Scores” to their customers. This is all part of the ‘Credit-Sells’ industry.

The scoring model they offer depends on the credit card company, for instance:

  • Capital One Credit Tracker is based on a TransUnion model
  • Discover offers your TransUnion FICO Credit Card Score
  • Bank Of America offers your TransUnion FICO Credit Card Score

None of the scores offered by credit cards are exactly what lenders will be looking at when you’re looking to take out a mortgage, refinance your home, take out a student loan, or purchase/lease a new car. Though they are a helpful way to keep track of your scores.

Why FICO is preferable?

We recommend that individuals purchase their FICO 3B credit reports and scores in preparation of applying for a mortgage, loan, or car lease. FICO offers a variety of scores with this product that are the closet to what most lenders will use to access risk and will give you an idea of where your credit stands before loan shopping.

Educational credit scores are rarely advertised as such and can lead to confusion and frustration if a consumer relies on that score when applying for a mortgage. Here’ an example:

A potential property owner was looking for a home in Long Island. He started looking for properties after he ordered his “Credit Score” online and was pleased to find it was a 790. When he met with the agent he bragged about his excellent credit score and he was sure it would be a breeze to get loan approval. After viewing homes for 3 months the buyer finally went to a banker to get a pre-approval letter. While the banker was gathering information to send the letter the buyer found a property he and his wife loved. After the agent made the first offer the client got a phone call from the banker telling him his credit score was a 650 which meant he could not qualify for the loan. The buyer was shocked and did not understand the difference in score. When analyzing the credit with the banker it was clear he had some credit issues. This was very disappointing to both the buyer and the seller. His score problems would have been addressed much earlier if he had been informed that the score he needed to view was the FICO score and not the Vantage score.

If you have any questions about your scores / reports, reach out to a credit expert for a free consultation.

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