A credit score is a complex mathematical model that evaluates many types of information within a credit file. The credit score is then displayed as a number that reflects your credit risk level. Typically, a higher number indicates a lower credit risk. Your credit score is not physically stored in the credit file. Rather, it is generated at the time a lender requests your credit report and is then included as part of the report. This measure is used by a lender to help determine whether a person qualifies for a particular credit card, loan, or service.
Most credit scores estimate the risk a company incurs by lending a person money or providing them with a service. Specifically, the credit score reflects the likelihood that the person will make payments on time in the next two to three years. Keep in mind your credit score is a fluid number that changes daily as information is added or revised in your credit report. There are many different credit scores used in the financial service industry. Your score may be different from lender to lender (or from car loan to mortgage loan); depending on the type of credit scoring model that was used.
For some people, a given factor may be more important than for someone else with a different credit history. In addition, as the information in your credit report changes, so does the importance of any factor in determining your score. Thus, it is impossible to say exactly how important any single factor is in determining your score — even the levels of importance shown here are for the general population, and will be different for different credit profiles. What is important is the mix of information, which varies from person to person, and for any one person over time.
However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting.
Fallacy: My score determines whether or not I get credit.
Fact: Lenders use a number of facts to make credit decisions, including your credit score. Lenders look at information such as the amount of debt you can reasonably handle given your income, your employment history, and your credit history. Based on their perception of this information, as well as their specific underwriting policies, lenders may extend credit to you although your score is low, or decline your request for credit although your score is high.
Fallacy: A poor score will haunt me forever.
Fact: Just the opposite is true. A score is a "snapshot" of your risk at a particular point in time. It changes as new information is added to your bank and credit bureau files. Scores change gradually as you change the way you handle credit. For example, past credit problems impact your score less as time passes. Lenders request a current score when you submit a credit application, so they have the most recent information available. Therefore by taking the time to improve your score, you can qualify for more favorable interest rates. See how improved scores can lead to savings.
Fallacy: Credit scoring is unfair to minorities.
Fact: Scoring considers only credit-related information. Factors like gender, race, nationality and marital status are not included. In fact, the Equal Credit Opportunity Act (ECOA) prohibits lenders from considering this type of information when issuing credit. Independent research has been done to make sure that credit scoring is not unfair to minorities or people with little credit history. Scoring has proven to be an accurate and consistent measure of repayment for all people who have some credit history. In other words, at a given score, non-minority and minority applicants are equally likely to pay as agreed.
Fallacy: Credit scoring infringes on my privacy.
Fact: Credit scoring evaluates the same information lenders already look at — the credit bureau report, credit application and/or your bank file. A score is simply a numeric summary of that information. Lenders using scoring sometimes ask for less information " fewer questions on the application form, for example.
Fallacy: My score will drop if I apply for new credit.
Fact: If it does, it probably will not drop much. If you apply for several credit cards within a short period of time, multiple requests for your credit report information (called "inquiries") will appear on your report. Looking for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from auto or mortgage lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on the credit score.