What is the credit score ?

Credit Score Amorphous ?

For what is a very simple question, there is no simple answer.  The most important credit score is the FICO score.  FICO is named after the company (Fair Isaac Corporation) that created the credit algorithm that is generally used to assess a credit applicant’s credit risk.  In other words, the better your FICO score, the less likely it is that you will default on your loan.  This makes you a lower risk for the lender, which makes you a more desirable customer.

Many Credit Scores

But FICO is not the only credit score out there. There are a number of other organizations that offer credit scores and attempt to sell them to credit lenders.  However, for most, when applying for credit, the FICO score is the one that matters.

Birth of the Credit Score

Fair Isaac Corporation created and began marketing the FICO method in the early 1980s.  Before then, multiple lenders had attempted to assess credit risk with inconsistent results.  The FICO score has gone a long way to creating an objective assessment of credit risk that does not take into account such things as a person’s race or age.  Instead, it seeks to examine a person’s financial history and use only that history to tell potential lenders how much risk they are taking on by making a loan or providing credit cards.

Each Person Has Three FICO Scores

Each person actually has three FICO scores, one from each of the main credit bureaus (Equifax, TransUnion, and Experian).  Each of the credit bureaus has a database of credit history on a person.  This data is then run through the FICO algorithm, resulting in the FICO score for that credit history dataset.  So because each of the credit bureaus have slightly different data on each credit applicant, the FICO score for each applicant is slightly different for each of the bureaus.

Since it was originally released, the use of the FICO score has been broadened.  Now, the score can be used for everything from credit cards to deposits on telephones to approval of insurance policies.

Credit Score Method Secret

But despite the widespread use of the credit score, there is a great deal of uncertainty about the details.  For example, it is not even clear what the range of scores is.  It is generally accepted that the FICO score ranges from 300-850.  However, a little research can find contradictory ranges.    For most, however, this inconsistency is of very little relevance.

The median credit score in the United States is 723.  That means that one half of the people with credit scores are below 723 and one half of the people with credit scores are above 723.

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What does a credit score really say?

But what does a credit score really tell a lender?  If a person has a credit score below 499, that person is in the bottom 2% of people with credit scores.  It has been estimated that a person in the bottom 2% has an 87% chance of being 90-days late on a payment in the next 24 months.  This is hardly a good risk for a lender.

As the scores improve, the chances of a payment that is 90-days late decrease.  The score for someone in the 15th percentile (15% of people with credit scores have a worse credit score and 85% have a better score) is between 550 and 599.  For a person with that score, there is a 51% chance to have a 90-day delinquent payment over the next two years.  For those in the 60th percentile (60% of people with scores have worse credit scores and 40% have better scores), the score is between 700-749 and the risk of a 90-day delinquent payment over the next two years is 5%.  This is the percentile that includes the median score of 723.

Given that the scores are predictive of delinquency, the value of these scores to a lender cannot be overstated.  By knowing the likelihood of a delinquency or default, the lender can price a loan to balance the risk and reward of extending the credit.

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