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How does the credit score work?

Module by: Ed DeShields. E-mail the author

Summary: A credit score is a numerical rating that attempts to measure a borrower’s creditworthiness. The score indicates the borrower’s general payment behaviors—summarizing how often the person pays their bills and obligations on time.

What is a credit score?

A credit score is a numerical rating that attempts to measure a borrower’s creditworthiness. The score indicates the borrower’s general payment behaviors—summarizing how often the person pays their bills and obligations on time. A high credit score does not guarantee that a loan applicant will never default on a mortgage; however, that person represents a statistically smaller risk to a lender than a person with a low score. Lenders and creditors, therefore, are more likely to approve loans and offer their most-favorable terms to people with the highest scores.

Credit scores have been used for more than three decades by lenders and creditors as an objective way to decide whether to offer consumers credit cards, home loans and car loans.

The score is based on the data that a person has on record at the Credit Reporting Agency (Bureau). It is common for an individual’s score to differ slightly from one Bureau to another. That’s because the score is developed only from the credit information on file at each particular bureau, and information may vary from one Bureau to the next. The Bureaus can only report the data that is sent to them from the lenders, creditors and companies that report such data to them.

Scores are determined by weighing several factors in a person’s credit record, including payment history, balances, number and types of credit accounts. By using a formula, results can be more objective than humans relying on different criteria to create a measurement. Credit scores do not consider a borrower’s race, gender, religion, age, income, marital status, or national origin. But mathematical formulas have limitations. For example, a person who has always paid cash for purchases will score low due to a lack of credit history. Many lenders, therefore, do not rely exclusively on a credit score and will take other factors into account that may mitigate a poor credit score.

Most credit scoring models are kept secret because the model providers sell their scores to lenders willing to pay for them. This often makes it very difficult for the consumer to understand how their actions can affect their score. However, there is at least one vendor who provides information on how your actions will raise or lower your score. This company, Community Empower provides financial and credit education to consumers in an easy to use and convenient website, or can be obtained through hundreds of credit counseling professionals, lenders or not-for-profits counseling organizations.

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