Credit Scores: What Are They and Where Do They Come From?

You may have read (or watched) The Lord of the Rings. If so, then I think you’ll understand this analogy: a credit score is the consumer financial equivalent of the “One Ring to rule them.” In other words, your credit score is the single most powerful three-digit number controlling your financial freedom in existence. It rules your ability to finance a car, obtain credit cards (and at the most optimal rates), and even impacts the insurance premiums you pay! Simply put, the better your credit score is, the more benefits you receive as a consumer in nearly every financial aspect of your life. So, if you want to control your financial freedom, you should understand what a credit score really is and the various organizations that issue these all-powerful three-digit numbers!

What is a credit score?

In a nutshell, a credit score is a three-digit number that is supposed to reflect your likelihood of repaying a debt. It is based on a consumer’s credit history, such as the number of accounts you have open, your payment history, unpaid debt, foreclosures, bankruptcies, and new applications for credit, i.e., credit inquiries. 

Potential lenders use credit scores to determine one’s creditworthiness, or how worthy an individual is of receiving new credit and trusting them to pay their debts back accordingly. It also impacts your buying power on major financial decisions, such as renting or purchasing a home, buying insurance, and increases your chances of securing a job.

What are credit scoring models and where do they come from?

A credit scoring model is a mathematical formula used to determine one’s credit score. Many people are under the impression that there is a single credit score when several different scoring models exist. You may be familiar with FICO® and VantageScore®. These two are the leading consumer credit scoring models that analyze an individual’s credit report and use that information to determine their credit score.

The scores for both FICO® and VantageScore® range from as low as 300 to as high as 850, with the latter considered perfect. Although they both try to determine the same outcome, the models’ methods are not identical.

FICO® utilizes a bureau-specific scoring model, which means that models for TransUnion, Equifax, and Experian will all differ from each other. They group their data into the following five categories:

  • Payment history (35%)
  • Amount owed (30%)
  • Length of credit history (15%)
  • New credit (10%)
  • Credit mix (10%)

VantageScore® operates on a single tri-bureau model meaning the same model is used on a credit report, whether from TransUnion, Equifax, or Experian. They group their data into the following five categories:

  • Total credit usage, balance, and available credit (extremely influential)
  • Credit mix and experience (highly influential)
  • Payment history (moderately influential)
  • New accounts opened (less influential)
  • Age of credit history (less influential)

Aside from FICO® and VantageScore®, several other credit scoring models exist, including TransUnion’s TransRisk, Experian’s National Equivalency Score, Credit Xpert Credit Score, CE Credit Score, and Insurance Score. Although not as well-known, they each serve their specific purpose.

  • TransRisk generates a score based on TransUnion’s data. They determine the consumer’s risk on new accounts rather than existing accounts. Lenders do not commonly use this particular credit scoring model. Scores have also been reported to be lower than FICO® scores.
  • Experian’s National Equivalency Score uses a scoring system of 0-1,000, applying the typical categories: credit length, credit mix, credit utilization, payment history, total balances, and the number of inquiries. However, Experian has never publicized the weight of each category.
  • Credit Xpert Credit Score inspects credit scores to further improve them. This scoring model was developed to help businesses approve more loans for new accounts.
  • Insurance Score is used by insurance companies to determine a consumer’s risk and what their premium will be. Scores range from 200-997 but will vary according to the type of insurance. 

How do I avoid credit score errors?

As you’ve now read, your credit score is significantly tied to the payment history of your accounts. Unfortunately, your account holders and credit reporting agencies can make mistakes when reporting your credit, which then reduces your credit score. There really is no way for you to avoid these initial mistakes, but you can make every effort to keep on top of your credit reports to correct any errors that do occur. Despite your best efforts and initiating numerous disputes to get your credit report fixed, credit reporting agencies and account holders may still refuse to do the right thing. If that happens, a Fair Credit Reporting Attorney might be the next best step for you.

If you or someone you know is in need of a Fair Credit Reporting Act attorney to assist with correcting inaccurately reported credit information (despite having initiated disputes with credit reporting agencies), then contact The Kim Law Firm today for your free case evaluation. Call us at (855) 996-6342 or fill out our contact form.