by Thom Fox

Lenders review a variety of information whenever they need to decide whether a consumer loan applicant represents an acceptable level of risk. In this process, lenders review one or more credit scores. A credit score is typically a three-digit number that tells a lender how likely an individual is to repay a loan, and whether that person’s payments will be made on time. 

FICO Scores
The standard credit scoring system is one that was developed by the Fair Isaac Corporation (FICO). It allows the information within your credit report to be distilled into a three-digit number between 300 and 850. The higher the score, the more creditworthy the consumer is considered to be. Why is having a high credit score important? Because the higher your credit score is, the lower the interest rate that will be offered to you when you need to finance a purchase.

To calculate a credit score, each aspect of an applicant’s relevant financial information is assigned a value. This will include such items as the number of lines of credit that person has and how the individual has managed the credit. The credit score is plugged into a formula, and after some additional number crunching, an overall score is determined.

The Five Major Components of a FICO Credit Score 
Payment History: 35%
Amounts Owed: 30%
Length of Credit History: 15%
New Credit: 10%
Types of Credit Used: 10%
 
You Actually Have Three FICO Scores
There are three major credit bureaus—TransUnion, Equifax, and Experian—and each maintains separate credit files on you because different creditors report to different bureaus. A credit bureau, also referred to as a credit reporting agency, is simply a clearinghouse for credit history information. Creditors provide these bureaus with information on how their customers pay their bills. Because each of these agencies has different information on how you manage your credit, the scores that each provides to lenders vary. 

Under this system, credit-reporting agencies used their own proprietary formulas, based on the FICO model, to generate their own scores. Equifax called its FICO-based score the “Beacon Score,” Experian used the more descriptive “Experian/Fair Isaac Risk Model Score,” while TransUnion referred to its as the “Empirica Score.”

No matter the name of the resulting score, the numnrt is only as accurate as the data being used in the equation. If the information were identical at all three credit-reporting agencies, their scores would generally be within a few points of each other. Unfortunately, this is not the case. Lenders generally report to one of bureaus, at tops two, but not to all three. That’s why your file at one bureau may vary significantly from your file at the others; they haven’t received the same data about you. To further complicate matters, the reporting agencies may also report the same information in different ways, resulting in slight fluctuations in each of the scores. 

Your Score Can Change Daily!
Every time you make a payment to your creditor, use your credit card for a purchase, or open a new line of credit, you affect your score. This is because the FICO scoring model considers a variety of circumstances when calculating your score. If any of these circumstances changes, so will your score. Therefore, your credit score today can vary greatly from your score tomorrow, or a week from now.

Reviewing Credit
The Fair and Accurate Credit Transactions Act (FACTA) of 2003 allows consumers to receive one free copy of each of their credit reports each year from each of the three major credit bureaus. You can receive your copy by contacting them directly at the numbers listed below, or by visiting www.annualcreditreport.com. Beware: There are many other websites claiming to offer free credit reports, but they usually include some stipulation that you must sign up for one of the services they offer.  
 
Equifax
PO Box 740241, Atlanta, GA 30374-0241
800-685-1111
Website: www.equifax.com

Experian
PO Box 2002, Allen, TX 75013-2002
888-397-3742
Website: www.experian.com

TransUnion
PO Box 2000, Chester, PA 19022
800-888-4213
Website: www.tuc.com

 
Thom Fox is a public speaker and personal finance author who has helped to develop numerous programs for both young people and adults. As an expert in the field of personal finance, Mr. Fox has served as a guest lecturer for the Bruce Wells Scholarship Upward Bound program at Clark University and a panelist for both the Nichols College “Cycle of Debt in America” student Q & A and the California JumpStart Coalition “Innovative Financial Literacy for Youth” conference.