Need Credit or Insurance? Your Credit Score Helps Determine What You’ll Pay Ever
wonder how a lender decides whether to grant you credit? For years,
creditors have been using credit scoring systems to determine if you’d
be a good risk for credit cards, auto loans, and mortgage
These days, many more types of businesses — including insurance
companies and phone companies — are using credit scores to decide
whether to approve you for a loan or service and on what terms. Auto and
homeowners insurance companies are among the businesses that are using
credit scores to help decide if you’d be a good risk for insurance. A
higher credit score means you are likely less of a risk, and in turn,
means you will be more likely to get credit or insurance — or pay less
The Federal Trade Commission (FTC), the nation’s consumer protection agency, wants you to know how credit scoring works.
What is credit scoring?Credit
scoring is a system creditors use to help determine whether to give you
credit. It also may be used to help decide the terms you are offered or
the rate you will pay for the loan.
about you and your credit experiences, like your bill-paying history,
the number and type of accounts you have, whether you pay your bills by
the date they’re due, collection actions, outstanding debt, and the age
of your accounts, is collected from your credit report. Using a
statistical program, creditors compare this information to the loan
repayment history of consumers with similar profiles. For example, a
credit scoring system awards points for each factor that helps predict
who is most likely to repay a debt. A total number of points — a credit
score — helps predict how creditworthy you are — how likely it is that
you will repay a loan and make the payments when they’re due.
insurance companies also use credit report information, along with
other factors, to help predict your likelihood of filing an insurance
claim and the amount of the claim. They may consider these factors when
they decide whether to grant you insurance and the amount of the premium
they charge. The credit scores insurance companies use sometimes are
called “insurance scores” or “credit-based insurance scores.”
Credit scores and credit reports Your
credit report is a key part of many credit scoring systems. That’s why
it is critical to make sure your credit report is accurate. Federal law
gives you the right to get a free copy of your credit reports from each
of the three national consumer reporting companies once every 12 months.
Fair Credit Reporting Act (FCRA) also gives you the right to get your
credit score from the national consumer reporting companies. They are
allowed to charge a reasonable fee, generally around $8, for the score.
When you buy your score, often you get information on how you can
order your free annual report from one or all the national consumer
reporting companies, and to purchase your credit score, visit www,annuacreditreport.com, call toll-free 877-322-8228, or complete theAnnual Credit Report Request Formand mail it to: Annual Credit Report Request Service, P. O. Box 105281, Atlanta, GA 30348-5281. For more information, seeYour Access to Free Credit Reports.
How is a credit scoring system developed?To
develop a credit scoring system or model, a creditor or insurance
company selects a random sample of its customers, or a sample of similar
customers, and analyzes it statistically to identify characteristics
that relate to risk. Each of the characteristics then is assigned a
weight based on how strong a predictor it is of who would be a good
risk. Each company may use its own scoring model, different scoring
models for different types of credit or insurance, or a generic model
developed by a scoring company.
the Equal Credit Opportunity Act (ECOA), a creditor’s scoring system
may not use certain characteristics — for example, race, sex, marital
status, national origin, or religion — as factors. The law allows
creditors to use age in properly designed scoring systems. But any
credit scoring system that includes age must give equal treatment to
What can I do to improve my score?Credit
scoring systems are complex and vary among creditors or insurance
companies and for different types of credit or insurance. If one factor
changes, your score may change — but improvement generally depends on
how that factor relates to others the system considers. Only the
business using the scoring knows what might improve your score under the
particular model they use to evaluate your application.
scoring models usually consider the following types of information in
your credit report to help compute your credit score:
you paid your bills on time? You can count on payment history to be a
significant factor. If your credit report indicates that you have paid
bills late, had an account referred to collections, or declared
bankruptcy, it is likely to affect your score negatively.
you maxed out? Many scoring systems evaluate the amount of debt you
have compared to your credit limits. If the amount you owe is close to
your credit limit, it’s likely to have a negative effect on your score.
long have you had credit? Generally, scoring systems consider the
length of your credit track record. An insufficient credit history may
affect your score negatively, but factors like timely payments and low
balances can offset that.
you applied for new credit lately? Many scoring systems consider
whether you have applied for credit recently by looking at “inquiries”
on your credit report. If you have applied for too many new accounts
recently, it could have a negative effect on your score. Every inquiry
isn’t counted: for example, inquiries by creditors who are monitoring
your account or looking at credit reports to make “prescreened” credit
offers are not considered liabilities.
many credit accounts do you have and what kinds of accounts are they?
Although it is generally considered a plus to have established credit
accounts, too many credit card accounts may have a negative effect on
your score. In addition, many scoring systems consider the type of
credit accounts you have. For example, under some scoring models, loans
from finance companies may have a negative effect on your credit score.
models may be based on more than the information in your credit report.
When you are applying for a mortgage loan, for example, the system may
consider the amount of your down payment, your total debt, and your
income, among other things.
your score significantly is likely to take some time, but it can be
done. To improve your credit score under most systems, focus on paying
your bills in a timely way, paying down any outstanding balances, and
staying away from new debt.
Are credit scoring systems reliable?Credit
scoring systems enable creditors or insurance companies to evaluate
millions of applicants consistently on many different characteristics.
To be statistically valid, these systems must be based on a big enough
sample. They generally vary among businesses that use them.
designed, credit scoring systems generally enable faster, more
accurate, and more impartial decisions than individual people can make.
And some creditors design their systems so that some applicants — those
with scores not high enough to pass easily or low enough to fail
absolutely — are referred to a credit manager who decides whether the
company or lender will extend credit. Referrals can result in discussion
and negotiation between the credit manager and the would-be borrower.
What if I am denied credit or insurance, or don’t get the terms I want?If
you are denied credit, the ECOA requires that the creditor give you a
notice with the specific reasons your application was rejected or the
news that you have the right to learn the reasons if you ask within 60
days. Ask the creditor to be specific: Indefinite and vague reasons for
denial are illegal. Acceptable reasons might be “your income was low” or
“you haven’t been employed long enough.” Unacceptable reasons include
“you didn’t meet our minimum standards” or “you didn’t receive enough
points on our credit scoring system.”
you can be denied credit or insurance — or initially be charged a
higher premium — because of information in your credit report. In that
case, the FCRA requires the creditor or insurance company to give you
the name, address, and phone number of the consumer reporting company
that supplied the information. Contact the company to find out what your
report said. This information is free if you ask for it within 60 days
of being turned down for credit or insurance. The consumer reporting
company can tell you what’s in your report; only the creditor or
insurance company can tell you why your application was denied.
a creditor or insurance company says you were denied credit or
insurance because you are too near your credit limits on your credit
cards, you may want to reapply after paying down your balances. Because
credit scores are based on credit report information, a score often
changes when the information in the credit report changes.
If you’ve been denied credit or insurance or didn’t get the rate or terms you want, ask questions:
the creditor or insurance company if a credit scoring system was used.
If it was, ask what characteristics or factors were used in the system,
and how you can improve your application.
you get the credit or insurance, ask the creditor or insurance company
whether you are getting the best rate and terms available. If you’re
not, ask why.
you are denied credit or not offered the best rate available because of
inaccuracies in your credit report, be sure to dispute the inaccurate
information with the consumer reporting company. To learn more about
this right, seeHow to Dispute Credit Report Errors.
FTC works for the consumer to prevent fraudulent, deceptive, and unfair
business practices in the marketplace and to provide information to
help consumers spot, stop, and avoid them. To file acomplaintor to getfree information on consumer issues, visitftc.govor call toll-free, 1-877-FTC-HELP (1-877-382-4357); TTY: 1-866-653-4261. The FTC enters consumer complaints into theConsumer Sentinel Network,
a secure online database and investigative tool used by hundreds of
civil and criminal law enforcement agencies in the U.S. and abroad.