Robert and Carrie were on the brink of realizing their decade-long dream of owning a home. They diligently prepared, assembled critical paperwork, and checked their credit reports before meeting a financier. Much to their bewilderment, their scores vastly differed among the three chief credit bureaus, though all scoring 700 or above with 720 as the pinnacle. Thus, they were confident they could leverage those scores for advantageous loan conditions. Their astonishment was palpable when their financier informed them that their score was a mere 680, insufficient for the lowest rate. Even worse, the proposed rate was nearly an entire point higher, leading to an added expense of around $3000 annually. So, what went awry? Why was the financier’s score drastically lower than the scores from their credit reports?
Welcome to the perplexing world of credit scoring, a domain synonymous with uncertainty where logic is subjective and exclusive to the financiers, often leaving us guessing about their ultimate decision. Making sense of how the FICO score functions (an original scoring model by the Fair Isaac Company) is a challenge in itself, only intensified with the introduction of two other scoring models and the varying criteria used by financiers. The only predictable factor in this unpredictable landscape is that clients continue to be in the dark about how financiers conclude their scores while applying for house loans, car loans, and credit cards.
CURRENT CREDIT SCORING SCENARIO
Presently, three distinct credit scoring models exist, all designed to evaluate the borrower’s credit risk. Each model produces scores based on elaborate algorithms that sift through a plethora of data and statistics from credit histories. Highly confidential, these algorithms make the scores appear scientific yet inscrutable. Due to the lack of transparency in these models and how financiers interpret scores, this system fundamentally operates against the borrower’s interests, particularly when a tiny 10-point difference can add up to tens of thousands of dollars over the lifetime of a loan.
Here’s a general understanding; every model fundamentally comprises some key elements but might assign different weights to each. For instance, the estimated weightings in FICO are: Payment history (35%), debt usage (30%), length of credit history (15%), new credit (10%) and credit diversity (10%).
FICO initially sold its scores to credit bureaus, who then resold them to financiers and consumers. Over time, credit bureaus, with their extensive credit data, decided to stop acting as intermediaries and start formulating their own scores for heftier profits. This unsurprisingly brought legal complications with FICO, which were settled in court. Experian then conceived its own scoring model called PLUS.
Hence, there are three primary models now: FICO, Vantage, and PLUS. Each comes with its unique weighting system, formula, and scoring range, subject to periodic modifications. The ranges for each are FICO- 350 to 850, Vantage- 501 to 990, and PLUS- 330 – 830.
WHICH ONE IS THE MOST ESSENTIAL?
The most influential model for borrowers is the one majorly preferred by financiers. Nevertheless, financiers are known to employ differing scores. Some exclusively trust FICO, some use both FICO and Vantage. Others create a unique blend with the available data to gauge credit risk. The PLUS score is purely “educational” and thus, not utilized by financiers at all. As of now, FICO dominates with a 95% market penetration, with Vantage gaining momentum, often in tandem with FICO.
If you crosscheck your credit scores from the credit bureaus, you should be aware that your score might significantly differ from the financier’s interpretation. To manage your credit activities in a way that improves your score, you should periodically monitor your credit report. Seeing your credit report scores improve could suggest a likely improvement in your FICO score as well.
Though it can put consumers who missed out by a small margin into a difficult situation, the advent of new consumer credit laws and screening by the Consumer Finance Protection Bureau (CFPB) promises more transparency in credit scoring determination and its interpretations by the financiers. Financiers are now mandated to reveal the credit score basis for unfavorable loan conditions or credit cards refusal, which indicates positive change.
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