Credit score

From Academic Kids

A credit score is a numerical index which represents an estimate of an individual's financial creditworthiness. It is based on a subset of the information in an individual's credit report. Lenders, such as banks and credit card companies, use credit scores to determine credit limits and interest rates.

The best-known credit score in the United States is the FICO score calculated using mathematical formulae developed by the Fair Isaac Corporation. The three major American credit-report agencies (Equifax, Experian and Trans Union) all use variations on this scoring formula under different names, the best-known of which are the Beacon score and the Emperica score.

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FICO scores and its variants are designed to measure the risk of default, by taking into account various weighted factors:

  • 35% punctuality of payment in the past
  • 30% capacity used, i.e., ratio of current revolving debt (e.g. credit card balances) to total available revolving credit (e.g. credit limits)
  • 15% length of credit history
  • 10% types of credits used (installment, revolving)
  • 10% amounts of credits obtained in the recent past

The above percentages are approximate. Current income and employment history do not influence the FICO score.

There are other special factors which can weigh on the FICO score. One is that any monies owed because of a court judgement, tax lien, or similar carry an extra negative penalty, especially when recent. Having above a certain number of consumer finance company credit accounts also carries a negative weight (critics say that this causes a vicious cycle, locking people into continuing to use consumer finance companies). The number of recent credit checks also can weigh down the score, although the credit agencies allow for credit checks made within a certain window of time to not aggregate, so as to allow the consumer to shop around.

FICO scores range from about 300 to 850 and exhibit a left-skewed distribution with a median around 725. A score above 720 is considered to be "good credit," and a score below 600 is considered to be poor.

In September 2004, a Texas utility company began setting individualized electricity prices based on credit score.

As a result of the FACT Act (Fair and Accurate Credit Transactions Act), free reports will be phased in during a nine-month period, rolling from the West Coast to the East beginning December 1, 2004. Beginning September 1, 2005, free reports will be accessible to all Americans, regardless of where they live.

Recently, some of the agencies which generate credit scores have also been generating insurance scores, which insurance companies then use to rate the quality of potential customers.

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