Think You Know Your Credit Score? Think Again!

These days, many people are concerned about the magical 3-digit number known as a credit score. And despite all the hype, it’s fascinating that many people are unaware that they actually have more than one score. Truth is, we know relatively little about the various scoring formulas that crunch our credit report information into a tidy 3-digit number. In fact, the developer of credit scores, Fair Isaac and Company, or FICO, offers at least 49 different scoring models.   Many of these models produce scores you and I never see.  Is that good or bad, and what does that mean for your wallet?  We’ll tell you.

A recent Consumer Financial Protection Bureau report sanctioned by the Dodd-Frank Wall Street Reform Act is helping shed light on this subject. The report was commissioned to study the “nature, range, and size of variations between the credit scores sold to creditors and those sold to consumers by consumer reporting agencies that compile and maintain files on consumers on a nationwide basis … and whether such variations disadvantage consumers.” The CFPB came across some interesting findings. According to their research, one out of five consumers would likely receive a different credit score than a prospective lender. Why? The scores we purchase are considered educational scores, and are calculated differently than those used in the decision to extend credit. Based on the type of loan you’ve applied for, lenders can choose from a variety of statistical models to best determine the risk you represent in repaying the loan.

These differences are problematic because they make it difficult to gauge our creditworthiness prior to applying for credit. For example, let’s say you’re going to shop for a new automobile. Before setting foot on a car lot, you order a copy of your credit report, thinking that it will help you determine whether you’re being quoted a fair interest rate. Your score comes in at 680, which might be considered near prime credit, maybe a B, B+. You find the car you want and the dealership submits your application for financing. The statistical model used by the bank they deal with assesses your credit score at 660, which may disqualify you for the near-prime rate. This could even push you into the sub-prime category, which would cost you much more in interest payments.

Okay, so what can you do if the only credit scores available to you aren’t the same as the score your potential lenders will see? For starters, make sure your credit profile is accurate. No matter what statistical model is used, your credit score is driven by the information currently in your credit report. Inaccurate information may be the difference between being approved or denied for a loan, and whether you’ll receive a lower or higher interest rate. Before shopping for major credit items, be sure to give your credit reports a thorough review. Each of the major credit bureaus, TransUnion, Experian, and Equifax, are required to provide you with at least one free copy of your credit reports every 12 months, but you have to ask. You can access your reports by visiting AnnualCreditReport.com.

When it comes to an expensive purchase, like a house or a car, you have to shop around. That’s common sense.  But some people are hesitant to shop because they think multiple applications for credit will bring down their score. That’s not necessarily the case. In fact, according to the Consumer Financial Protection Bureau, each inquiry may only reduce your score by up to 5%. And when you’re shopping for a mortgage, automobile or student loan, the scoring model is somewhat forgiving. Inquiries made for these types of loans within a 30 to 45-day time frame are considered as just one inquiry. So, if you’re looking for the best interest rate on a mortgage, car or student loan, as you should, you can submit multiple applications for credit within that 30 to 45 day period and it will only result in a single reduction. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.

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