Ever wonder why you can go online and be approved for a credit card within 60 seconds? Or get pre-qualified for a car without anyone even asking you how much money you make? Or why you get one interest rate on your home loan, while your neighbor gets
another? The answer has to do with your credit score. Credit scores are used extensively, and if you’ve gotten a mortgage, a car loan, a credit card or auto insurance, the rate you paid was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.
Your credit score is a number generated by a mathematical algorithm — a formula — based on information in your credit report, as that information is compared to other credit profiles with similar matching characteristics as your credit file. The resulting number is a highly accurate prediction of how likely you are to pay your bills on time, or conversely, go delinquent on a debt.
Credit scores are used extensively, and if you’ve gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.
Lenders can use one of many different credit-scoring models to determine if you are creditworthy. Different models can produce different score ranges. However, lenders use some scoring models more than others. The FICO score is one such popular scoring method.The FICO scoring models range from
300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher will get you the most favorable interest rates on a mortgage, according to data from Fair Isaac Corp., a California-based company that developed the first credit score as well as the FICO score.Currently, each of the three major credit bureaus uses their own version of the FICO scoring model — Equifax uses the BEACON model, Experian uses the Experian/Fair Isaac Risk Model and TransUnion uses the EMPIRICA model. The three models can come up with varying scores because they use different algorithms. (Variance can also occur because of differences in data contained in the source data from each credit bureau.)That could change, depending on whether a new credit-scoring model catches on. It’s called the VantageScore. Equifax, Experian and TransUnion collaborated on its development and will all use the same algorithm to compute the score. Its scoring range runs from 501 to 990 with a corresponding letter grade from A to F. So, a score of 501 to 600 would receive an F, while a score of 901 to 990 would receive an A. Just like in school, A is the best grade you can get.
What’s the Big Deal?
No matter which scoring model lenders use, it pays to have a great credit score. Your credit score affects whether you get credit or not, and how high your interest rate will be. Whether you are dealing with a mortgage banker, mortgage broker, or any mortgage company, a better score will result in a lower interest rate.The difference in the interest rates offered to a person with a score of 520 and a person with a 720 score is 4.36 percentage points, according to Fair Isaac’s Web site. On a $100,000, 30-year mortgage, that difference would cost more than $110,325 extra in interest charges, according to Bankrate.com’s mortgage calculator. The difference in the monthly payment alone would be about $307.
Powerful Little Number
If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there’s a good chance your score was pulled. If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line — or charge you a higher interest rate, according to a credit scoring study by the Consumer Federation of America and the National Credit Reporting Association.
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