• How a credit score is calculated

    How-Credit-Scores-Calculated1Vantage (consumer score) VS. FICO (bank score)

    Fair Isaac and Vantage Score hold their credit scoring formulas as a close secret much like the formula for Coca-Cola or your grandma’s legendary double chocolate-chip cookies. This can be very frustrating for consumers when they see remarks on the credit report like “too many revolving debt accounts” and not knowing exactly that means.

    Fortunately, Fair Isaac and Vantage Score have issued some public information about how they calculate credit scores. Let’s take a look at the various factors:

    The Vantage Score is based on 6 variables whereas FICO uses 5. Here is a comparison:

    Vantage Score

     

    FICO Score

     

    Payment history

    32%

    Payment history

    35%

    Utilization

    23%

    Length of credit

    15%

    Balances

    15%

    Amounts owed

    30%

    Depth of credit

    13%

    Types of credit

    10%

    Recent credit

    10%

    New credit

    10%

    Available credit

    7%

     

     

    Total

    100%

    Total

    100%

    – Payment History: The top rated factor for both models is payment history. This is because lenders want to know a person’s payment history–past and present. This category can be broken down into three subcategories:

    • Recency – This is the last time a payment was late. The more time that passes the better.
    • Frequency – One late payment looks a heck of a lot better than a dozen.
    • Severity The “Hierarchy of madness” so to speak, rest on the logic that a payment 30 days late is not as serious as a payment 60 or 120-days late. Collections, tax liens, foreclosures, repossessions, charge-offs and bankruptcies are credit score killers.

    How much is owed: The score looks at the total amount owed on all accounts as well as how much you owe on different types of accounts (mortgage, auto, etc). Using a higher percentage of the credit limits will worry lenders and hurt the credit score. People who max out their limits have a much greater risk of default.

    Utilization: When it comes to revolving debt-credit cards, the formula looks at the difference between the high limit and balances. For Example, let’s say your customer has a MasterCard with a credit limit of $10,000 and they have spent $2,000 of it. This is a 20% utilization ratio. The lower the ratio, the higher the credit score. So, if your client’s are looking for a quick credit score boost, have them pay down any accounts they can. Don’t expect this to be instantaneous as it can take up to 45 days for the credit bureaus to update reports.

    One more important tidbit, CLOSED ACCOUNTS do not help and can hurt if there is a balance remaining. Therefore, tell clients not to close accounts. A long perpetuated myth has been to close accounts that are not in use but this will hurt consumers in several ways. As you now know, overall and individual account utilization plays a major role in credit scoring- if consumers close old accounts, their overall utilization rate will increase which will cause their score to decrease. In today’s tightening credit markets the availability of credit has drastically changed, having accounts that have been established will serve as a “Safety Net” if the consumer finds themselves in need of some emergency funds.

    – Length of credit history / Depth of credit: This is less important than the previous factors, but it still matters. It considers (1) the age of the oldest account and (2) the average age of all your accounts. It is possible to have a good score with a short history, but typically the longer the better. Young people, students, and others can still have high credit scores as long as the other factors are positive. If a person is new to credit then there is little they can do to improve a credit score. The only solution is to open an account and be patient.

    Average age of accounts is another important reason to keep all accounts open. If a consumer has multiple accounts that they’ve had for some time but don’t use- they are still benefiting from the average age of the accounts open in their credit file. It is a good idea to tell your clients to use each of their accounts at least once every 6 months. This serves multiple purposes. Credit issuers must reserve the money offered in credit limits for their clients use, so they don’t like having accounts sitting dormant that are not making them money, if an account sits dormant for a long enough time, many creditors nowadays will cancel the account due to inactivity. Additionally credit reporting agency will calculate an account as inactive if there has not been any activity in the most recent 6 month period of time, an inactive account does not benefit your score as much as an active account.

    – New Credit / Recent Credit: New credit is not always a bad thing. However, opening new accounts can hurt a credit score, particularly if a consumer applies for lots of credit in a short time and doesn’t have a long credit history. The score factors in the following:

    • How many accounts the consumer applied for recently
    • How many new accounts the consumer has opened
    • How much time has passed since the consumer applied for credit
    • How much time has passed since the consumer opened an account

    The model looks for “rate shopping.” Shopping for a mortgage or an auto loan may cause multiple lenders to request your credit report many times each, even though a person is only looking for one loan. Auto dealers are notorious for running 3 to15 credit reports. This is called shot gunning the credit. Luckily, to compensate for this, the score counts multiple auto and mortgage specific inquiries in any 30-day period as just one inquiry. The specific calculation for cut-off dates and types is confusing, we will go over that in detail in upcoming chapters.  

    For most people, a credit inquiry will take less than five points off their score. However, inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk. According to MyFico.com, people with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports.

    – Types of credit you use / depth of credit: Both models want to see a healthy mix of credit, but they are vague on what this means. They recommend you have a balance of both revolving debts like credit cards and installment loans like auto loans or a mortgage.

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