Keeping Score in the Credit Game

Since the end of 1995, credit scoring has become the financing industry's hottest ticket.  Fair Isaac & company produced the most well-known scoring system, and it is often referred to as a FICO ("fy-ko") score.  Simply put, a FICO score is a number ranging from 350 to 900.  Usually, it's added to a consumer's credit report at the request of the lender.  The number is calculated by analyzing the consumer's past credit history, and - get this - lenders can use the score to help predict the future performance of the consumer on a loan.

Now this is one great tool.

Unlike golf, however, a low credit score is not going to win the game,   because the lower the number, the greater the probability of default.

FICO has kept their statistical scoring methods secret (shhhh). But we do know it uses the same guidelines most commonly reviewed by credit underwriters when assessing a potential client. There are 33 variables that can be grouped into five categories:

• Previous credit performance
• Current level of indebtedness
• Amount of time credit has been in use
• Pursuit of new credit
• Types of credit used

The FICO scoring system is quite elaborate, really, evaluating how all of these variables interrelate - even taking into account thousands of other mortgage repayment histories and their borrowers' credit histories. Isn't technology great?

Of interest to prospective borrowers as well as lenders, FICO scores include "reason codes."  These codes reveal what has had the most influence on lowering a credit score, such as:

• Current delinquency
• Too few accounts currently paid as agreed
• Too many credit inquiries (seeking new credit) in the last 12 months
• Proportion of balances to credit limits is too high on revolving accounts (may be at or  near the maximum amount allowed on the charge accounts)
• Too many revolving accounts and/or
• Too many "finance company" accounts
• Too many accounts opened in the last 12 months

Sounds reasonable.

In case you were wondering, the nation's three largest credit repositories - TRW, TransUnion and Equifax - contribute the data for calculating someone's credit score. The scores are released under such private labels as Equifax BEACON, TransUnion EMPERICA, and TRW Fair Issac FICO Score.

So all of this sounds great, you say. But really, why use credit scoring? Because credit scores are objective - and consistent. Most importantly, they can help predict mortgage default. In July of 1995, for instance, Freddie Mac released an industry letter encouraging the use of credit scores. Their research showed mortgages with lower credit scores did, indeed, have significantly higher default rates than mortgages with higher scores.

Now, don't go thinking about crystal balls or anything like that. But in October of 1995, Fannie Mae also issued an industry letter endorsing credit scores because of their predictive power. They suggested that applicants with low credit scores should have offsetting strengths, such as a larger down payment; lower debt-to-income ratios; more cash reserves; and/or a history of a good payment record on housing expenses.

In addition, credit scoring can be incorporated into the new automated underwriting systems now being used more and more frequently.

Warning! Warning! A lender should never deny a loan solely on the basis of a credit score. Remember, it is only one factor. A low score may simply indicate a need to more carefully scrutinize a potential borrower.  Besides, a credit score is just a snapshot in time. Any change in credit activity or performance will result in a change to the score. For example, if derogatory information is reported for an account, the credit score will decrease (boooo). But if a consumer works to remove this derogatory information, the score will increase (hooray).

If you happen to be on the borrowing side of the credit game, ask your lender if they use credit scoring and ask for a copy of your credit report.  A score of more than 660 can simply require basic review by the underwriter; 660 down to 620 may require a comprehensive analysis; and a score of 620 or lower will dictate a cautious, detailed study. If your score happens to be low, you may still want to improve it.

Some suggestions:

• Pay your bills on time, even if it's just the minimum due.
• Don't "max out" your credit cards.
• Don't add new credit cards unnecessarily - write in and close any you have but don't use.
• Don't let anyone inquire into your credit without your approval.
• Avoid tax liens and bankruptcy filings.
• Check your credit report only once a year, and read carefully to make sure it's accurate.