Credit Scoring is now used as a standardizing method of establishing the risks associated with offering credit services to a particualr individual. Before the widespread use of this method, over the last two decades, underwriters were the primary arbiters of whether or not a specific consumer received a mortgage, equity loan, insurance, or other similar financial service. This involved a degree of subjectivity which resulted in consumer dissatisfaction, complaints and pressure on financial institutions to find a more objenctive and universally recognizable series of metric to evaluate an individual's credit worthiness.
The idea of statistically codifying various forms of credit and consumer debt and obligations into a series of empirical values which could be algorithmically processed to derive a specific number gained ever more support. In 1989, the Fair Isaac Corporation, one of the world's major financial services companies, along with Equifax (we have more on Equifax here), developed the FICO Credit Score. This is at present the most widely used credit scoring system although it is by no means the only one. Other systems, including the Vantage and Nextgen systems are also widely used.
We specifically refer to FICO scoring as a "system" because Fair Isaac does not process and keep credit scores of consumers. What it provides to credit reporting bureaus is the proprietary mathematical algorithm to be used to generate a score based on information the bureaus themselves have. This is why it is possible for all three bureaus: Experian, Equifax and Transunion to have different FICO credit scores for any given individual. Although the algorithm is the same, the variables this method is used to process differ from company to company. Consumers therefore need to obtain their scores from each of the bureaus in turn. Fair Isaac does provide a service, My Fico, through which consumers can obtain one or more of their credit reports and scores from all three bureaus. As wehave noted, it's necessary to check ones credit report and correct all errors before applying for major forms of credit.
FICO score values are given from a value of 300 up to 850. The factors which influence the final figure are now known in genearal, but specific information on these is difficult to obtain. The five main factors (and the percentage of the total value they contribute) are:
35%: Payments track record
30%: Debt to Credit-Limit Ratio
15%: Duration of of credit history
10%: Forms of credit analysis
10%: Factor analyzing new credit sought
For each of the above, a consumer is compared with other consumers who fall within a range of his particular situation. Based on what is known of the likelihood of people within that range paying back their debts, values are assigned.
Determining exactly what scores define Good and Bad credit varies slightly according to which authoritative sources are investigated. It is clear however, that 770 and above is considered optimal. People who fall within this range obtain the best interest rates and credit terms. A value of 700 and above is generally considered Good. The national average has varied over the last few years from 720 to as low as 690. As can be imagined, in periods of economic difficulty, the national average value drops. A State by State breakdown of FICO scores throughout the US is informative. The national median hovers around 720. This is the value for which half of consumers fall below and the other half of consumers rise above. Bad credit, or subprime levels have generally been pegged at 620 and below.
All this is subject to some variability, however. When a tightening of credit occurs, lenders begin to require higher scores for an arbitrary loan. Similarly, the score value for what would be considered a subprime consumer can increase for certain financial service providers when economic times cause a significant number of people to experience credit scoring drops.