A credit score is a number that attempts to predict your “credit-worthiness” at any given moment. Officially, it’s supposed to predict how likely you are to become at least 90 days late on payments within the next twenty-four months. Credit scores are calculated using complex, secret formulas that are only known by the companies that produce them (although these companies have given us some general guidelines on how they calculate credit scores.)
A company called Fair Isaac Corporation pioneered the use of credit scores in 1956, but they didn’t become widely used by creditors until the 1980’s. In 1995, Fannie Mae and Freddie Mac recommended the use of credit scores in mortgage lending. From then on, credit scores became perhaps the single-most important tool for creditors when offering loans to consumers.
Now, credit scores are even used by insurance companies and other service providers in determining whether, and on what terms, they will offer their services to you. (Personally, we have real problems with the use of credit scores in the granting of insurance and other services. We have difficulty believing that someone doesn’t deserve home or car insurance because they got sick and fell behind on their bills. Unfortunately, we don’t get to set the rules. So, we just have to do everything we can to improve your credit scores so that you don’t have problems with anyone – creditors or service providers!)
There are now many different types of credit scores, developed by different companies, for use in different industries. For example, there are credit scores that are used solely for automotive lenders, credit card issuers, or finance companies. (Some commentators have suggested that, between the different credit scoring companies, there are more than 1000 different credit scoring models currently in use.) But, the most widely used credit score, by far, is the score developed by the Fair Isaac Company, the pioneer of credit scores.
The credit score developed by Fair Isaac is known as a “FICO” score (from the “Fair Isaac Corporation”). To determine a FICO score for a consumer, Fair Isaac developed a formula based on nearly forty different “characteristics” that it claims predict the likelihood that the consumer will repay their debts.
Fair Isaac also groups different classes of consumers according to key “attributes” and then compares a given consumer’s credit file to other consumers in that same group. For example, there may be a group of consumers who have filed for bankruptcy. There may be another group of consumers who have one late payment, and so on. Fair Isaac believes that separating consumers into groups of consumers with common key attributes makes the credit score even more foretelling of credit worthiness. This system is called a “scorecard” system.
But guess what? There’s more than one credit scoring model. Sure, there are other companies that have their own credit scoring system (we’ll talk about that in a minute), but, even Fair Isaac has more than one credit scoring model. In fact, they have many different credit scoring models.
The most commonly used model is known as the “Classic” FICO scoring model. This model uses 10 “scorecards” or groups of people with similar key attributes. But, Fair Isaac has also developed another scoring model called “Next Generation” or “NextGen” that uses 18 scorecards or groups. Fair Isaac believes that the NextGen scoring model is even more advanced and predictive than the Classic model. In addition, Fair Isaac has developed enhancements to the Classic model.
So, why should you care about this? Well, it’s a problem for us every day, because different creditors use different credit scoring models. Some may use the Classic FICO. Others may use the enhanced versions of the Classic FICO. Still others may use the NextGen FICO. And the result? Yes, that’s right, different scores.
A lender may pull a credit score for a potential borrower and get one score. But, if another lender uses a different credit reporting company for their credit report, it’s very possible that the credit score will be different. So, while the borrower would qualify for a certain loan based on one credit report and score, the borrower may NOT qualify using the second lender’s credit report. This can be a real problem for loans that are teetering on the edge anyway. (Some lenders, recognizing this problem, are allowing mortgage brokers to use the credit report and score from “their” credit provider, and will qualify the borrower based on that credit report.)