What is a Credit Bureau Score, and how is it calculated?
Credit bureau scoring is a scientific way of assessing how likely a borrower is to pay back a loan. A Credit Bureau Score is based on the data available in the borrower's credit report. The score measures the relative degree of risk a potential borrower represents to the lender or investor. It is not a measure of a borrower's income, assets, or bank account, although those and other factors are still considered by lenders and investors, independent of the score.
Fair, Isaac Credit Bureau Scores range from approximately 450 to 850 points, and are available through the three national credit data repositories (Equifax, Trans Union, and TRW). The scoring programs reside at these credit bureaus and are called:
This score is calculated at the repository, and is based solely on the data within that repository's individual credit file.
A Fair, Isaac Credit Bureau Score, sometimes referred to as a FICO score, is calculated by a system of scorecards. In developing these scorecards, Fair, Isaac uses actual credit data on millions of consumers, and applies complex mathematical methods to perform extensive research into credit patterns that forecast credit performance. Through this process, Fair, Isaac identifies distinctive credit patterns. Each pattern corresponds to a likelihood that a consumer will make his or her loan payments as agreed in the future. The score is based on all the credit-related data in the credit bureau report-- not just negative data such as missed mortgage payments or bankruptcies.
The types of credit information used in the credit bureau scorecards are typically the same items an underwriter would use to make a credit decision. These can include:
Types of credit in use and number of trade lines reported for each type:
Fair, Isaac observes tens of thousands of credit report histories of mortgage borrowers to determine which credit report items or combination of items are the most predictive of future risk. This data indicates the amount each item should contribute to a credit decision.
Fair, Isaac Credit Bureau Scores do not use race, color, religion, national origin, sex, marital status, or age as predictive characteristics. Occupation and length of time in present house are also not used in the scorecards. Any information that is not present in a credit file is not used in creating a Credit Bureau Score.
What does a score mean?
A Fair, Isaac Credit Bureau Score is a means of rank-ordering potential borrowers based on the likelihood that they will pay their credit obligations as agreed. A higher score indicates better credit quality. If all other things are equal, borrowers with a score of 660 are less likely to default on a loan than borrowers with a score of 580.
The Fair, Isaac Credit Bureau Score models at each credit repository are of similar design and the scores are scaled to indicate a similar level of risk across all three bureaus. In other words, a score of 680 at one bureau will represent the same relative risk as a score of 680 from another bureau. This risk is defined in terms of the number of accounts that remain in good standing compared to those that default.
How can a borrower increase their FICO score?
Over time a borrower can improve the information in his or her credit report by paying credit obligations on time and using credit wisely. As derogatory data in the credit report gets older, it affects the score less. A missed payment from four years ago will not count as much as a missed payment from six months ago.
A credit score, like a credit report can be thought of as a snap shot of an individual's changing credit record. If a request is made that another repository report be obtained to get an updated score, then the score is likely to change for many reasons; however, it is not possible to control how that score will change. The credit items on the report are updated often, so new items are likely to have been added since the previous report. Additionally, repeatedly requesting a borrower's credit report may substantially increase the number of inquiries on the repository report, which may affect the score adversely.
Doesn't using the score mean fewer people will get mortgage loans?
No, in fact, the opposite may be true. Credit Bureau scoring is just one of several ways that lenders and the secondary market decide whether to lend someone money, and under what terms. They set the underwriting Guidelines. The lender typically offers a mortgage product to the same number of borrowers irrespective of the use of scoring.
The lender uses the Credit Bureau Score to determine the acceptable level of risk for the product being offered. If the score on a borrower's credit report is too low for a given product, that does not mean the score is too low for other products. In the past we have seen that once lenders are able to accurately identify the credit risk of all applicants, they can create products designed and priced for various market segments, ultimately extending credit to more people.
Suppose a score if affected by derogatory credit information that the borrower believes is not his or hers?
Consumers who want to address what they believe is erroneous information on a mortgage report should contact the reporting agency which developed the report. As you know, the Fair Credit Reporting Act (FCRA) allows the credit reporting agency a "reasonable period of time", generally not to exceed 30 days, to reinvestigate consumer disputed items. A significant number of credit grantors use an automated system for investigating disputes and respond to the dispute within a few days. Most credit reporting agencies make a special effort to resolve disputed information affecting a mortgage decision. The lender can weigh these factors and documentation provided by the borrower.
If the derogatory information is removed, how much will the score increase?
Because the score uses all the credit-related data on the credit bureau report and takes into account compensating factors, removing or changing one specific derogatory item will not guarantee an increase in the Credit Bureau Score. In some cases a change in the credit bureau report would have little or not effect on the score. And because there are many scorecards using complex mathematical formulae at each of the repositories, it is not possible for us to estimate how much the score will change if specific derogatory information is removed from the single repository report.
What would happen if an applicant were to pay off balances and/or close some accounts?
It is not possible to ensure that scores would increase in this case. Such actions may upset the mix of available credit, and actually decrease the score. It is important to remember that the point of the scoring is not to calculate a debt ratio--the debt ratio is still considered by the lender independent of the score. The score reflects data available on the credit report to assess the consumer's current payment patterns as well as payment history.