Understanding Credit Risk Scores

Credit scoring has rapidly become the primary means of assessing a consumer’s creditworthiness. Financing decisions of all types are often made based on a consumer’s credit score.

Credit risk scores produced from models developed by Fair Isaac Corporation are commonly known as FICO® scores. FICO is the most popular scoring model used among lenders and creditors to calculate a consumer’s credit risk. This mathematical equation evaluates many types of information from a consumer’s credit report from a particular credit bureau. By comparing this information to the patterns found in thousands of past credit reports, scoring estimates the level of risk a lender or creditor is assuming.

Each of the national credit bureaus utilizes the FICO algorithm to provide credit scores. The bureaus each market their credit scores under a different name:

Fair Isaac Corporation continually upgrades its scoring models in order to provide the sharpest credit evaluation possible. The NextGen (next generation) credit score offers the latest innovations in credit risk analysis.

Each of the national credit bureaus also offers industry-specific scores. An industry-specific credit score allows lenders in the various industries to better assess certain factors in a consumer’s credit file. For instance, a lender in the automotive finance industry might request a score model that more closely evaluates the consumer’s auto loan payment history.

Although the scoring methodology is the same for each, the actual score is based on the credit data available in the consumer’s file, and may vary from bureau to bureau. A consumer's credit score may also vary, depending on the score model requested (Auto specific, bankruptcy, etc). Scores usually fall between 300 and 850 – the higher the score, the lower the potential risk posed by the consumer. Many factors come into play when determining the credit score, including:

• past payment history
• amount of debt
• length of time credit established
• search for and acquisition of new credit
• types of credit established

Not all consumers have a credit score available. This is usually due to too little credit data in their file. Generally, a consumer must have at least one active credit account in order to be scored. Even then, the less credit history a consumer has, the more unreliable their credit score may be. For instance, someone just out of college might have an excellent credit score because of their lack of credit history. A consumer may also lack a credit score because that consumer is investigating data in their credit file. In this case, their file may be flagged so that no credit score will be delivered during the investigation.

When a consumer’s credit score is delivered with their credit file, it will include reason codes, which explain why the consumer scored the way they did (or why no score was available). An undesirable credit score will improve over time as the consumer makes more on-time payments and uses their credit wisely. Also, existing derogatory data in the consumer’s credit history impacts the credit score less as time goes by. A missed payment from four years ago is less detrimental than a missed payment from six months ago.