Becoming credit-savvy is harder than it seems. This is largely due to the fact that the credit scoring system we use in the United States is complicated, at least at first glance.
But why is this the case? The Nerds are excited to explain – take a look at the details below.
Is the credit scoring system complicated?
If you’re having a hard time understanding how your credit score is determined, you’re not alone. A 2013 survey by the Consumer Federation of America revealed that many Americans are confused about the factors that affect their scores. For instance:
- Two-fifths believe that personal characteristics like age and marital status are used to calculate their scores. (They aren’t.)
- Only 7% know that applying for several loans in a 1-2 week window (also known as rate shopping) won’t lower their scores.
- More than one-quarter don’t know the key ways to raise their scores.
There are many conclusions to draw from this data, but one interpretation is that the complexity of our credit scoring system leads to certain misunderstandings. FICO, the company responsible for the most commonly used credit score in the United States, uses a host of data points and a sophisticated algorithm to create your score. It’s no wonder that so many people are in the dark about what impacts this three-digit number!
Believe it or not, a complicated credit scoring system leads to fairness
By now you might be shaking your fist in frustration, wondering why credit scoring can’t be more straightforward. But if you look a little deeper, you’ll see that there’s a good reason for the complexity.
For help in explaining this, the Nerds reached out to Anthony Sprauve, a senior consumer credit specialist at FICO. Sprauve emphasized that using a large number of variables to determine consumers’ scores is beneficial, because it provides an accurate and objective picture of how likely they are to repay borrowed money. He stated:
“For the FICO Score to identify as many creditworthy consumers as possible, it is important to look at a variety of information. … For example, if a person forgets to pay a bill one time, but has an otherwise spotless track record, doesn’t have much debt, and doesn’t apply for credit very often, then we want to be sure the FICO Score reflects the fact that the person is probably a creditworthy individual.”
We asked Sprauve to clarify another confusing point: Why do certain actions have a big impact on one person’s credit score, but only a small impact on another’s? He explained:
“Every person is in a unique situation. No two people have identical credit histories or credit reports, and the FICO Score is designed to take these differences into consideration. For example, the FICO Score of a consumer with a short credit history will be impacted more by one delinquency than a consumer with a very long history of consistently paying all her/his bills on time.”
So it seems that in using a lot of data points, weighting those points differently, and taking every individual’s situation into account, the credit scoring system seeks to be fair and comprehensive. It might be complicated, but it’s probably helpful, too.
Achieving a high score boils down to only a few behaviors
It’s comforting to know that the thorny nature of the credit scoring system is meant to benefit consumers. But if you want to make the most of your credit score, how are you supposed to know which steps to take?
Luckily, you don’t need to know every nuance of the system to build good credit. Scoring high on the FICO scale boils down to a few behaviors:
- Paying your bills on time – no exceptions!
- Staying out of credit card debt
- Getting started with credit as soon as you can
- Applying for new credit sparingly
- Keeping a good mix of credit accounts (revolving and installment) on your credit report
The takeaway: The credit scoring system is complex, but this probably benefits consumers like you and me. Just be sure to keep up with good credit habits, and you’ll be on your way to a great score in no time!
Confused credit user image via Shutterstock
Source Article http://ift.tt/1y39EC7
0 comments:
Post a Comment