Understanding Credit Scoring

Written By: Glenn Michaels

What is a Credit Score?

A credit score is a complex mathematical number generated that represents your estimated measure of credit risk. Typically, the higher the credit score, the less risk is associated with the debtor. Credit scores take into account numerous factors in your credit history and are generated at the time a creditor requests a credit report for a debtor. All creditors review the credit score along with the credit history. The credit score changes as the credit history changes. If new accounts are added, accounts are paid or paid off, collections and public records can make the credit score change. Every debtor’s credit score is very important because it determines the financial future of a debtor. The credit score is often used by a creditor to determine if a debtor qualifies for a credit card or a loan. Very often the credit score helps to determine if the debtor can obtain credit and how much.

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Why and how is a credit score used?

Most companies use the credit score to approve and to determine the interest rate to offer a debtor a credit card or loan. The higher the credit score the lower the interest rate. If the credit score is low either credit will be denied or the interest rate offered will be higher. A good credit score can save a debtor a lot of money due to more favorable terms. Most creditors look at the credit score as a measure of how likely the payments will be paid on time. Credit scores help creditors assess risk because they are consistent and objective so all consumers within credit score ranges will get the same offer.

Before credit scores a creditor might have denied based on subjective judgment by an underwriter. It was not consistent because human judgment was prone to mistakes and could be bias. Lenders used underwriters to make a decision about an applicant that may have little or no bearing on the applicant’s ability to repay the debt. Now all consumers benefit from the credit score system. No matter who a person is their credit score reflects their likelihood to repay a debt responsibly based on the past credit history and current credit status.

Who uses credit scores and how are they used?

Most banks, credit card issuers, auto lenders and retail stores use credit scores to quickly summarize a consumer’s credit to decide to issue credit or to approve a loan. The system saves the need to manually underwrite or review an applicant’s credit report to approve or deny the application. This also provides a faster and more predictable credit decision. There are many additional factors used in determining the issuance of credit. The creditors take into consideration the applicant’s income and the applicant’s ability to repay the credit being offered.

What impacts the credit score?

The following information is the factors that impacts a person’s credit score and vary depending on the information used by each credit bureau to determine the credit score.

Credit type, number of accounts and age of the accounts, total amount of debt on the credit report, Amount of credit balances to credit limits issued, amount of credit accounts that are in good standing, number of late payments and severity of late payments, number of recent credit inquiries.

Credit scores range from the low of 350 to the high of 850. The higher the credit score number represents the consumer’s ability to repay the credit issued or applied for.

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How does a credit score affect a consumer?

Low credit scores very often result in credit denials or unfavorable credit terms. A high credit score normally results in more credit application approvals with more favorable terms. It is important to know approximately what your credit score is. Credit score can and will change week to week.


About The Author

Glenn Michaels - As an NAMP® staff writer, Glenn Michaels is a mortgage underwriting instructor for Mortgage Underwriter University (www.MortgageUnderwriter.org). As a BBA & FHA DE Underwriter, Glenn is a Pace University graduate who also graduated from New York University’s School of Mortgage Finance. Glenn has conducted numerous training classes and has worked in the mortgage banking industry for 38 years. If you're interested in becoming a writer for NAMP®, please email us at: contact@mortgageprocessor.org.


Opinion-Editorial (Op-Ed) Disclaimer For NAMU® Library Articles: The views and opinions expressed in the NAMU® Library articles are those of the authors and do not necessarily reflect any official NAMU® policy or position. Examples of analysis performed within this article are only examples. They should not be utilized in real-world application as they are based only on very limited and dated open source information. Assumptions made within the analysis are not reflective of the position of NAMU®. Nothing contained in this articles should be considered legal advice.