Credit Scoring
- A quantitative system lenders use to assess how likely a borrower is to repay a loan.
- Models assign a numeric credit score based on data such as credit reports, bank statements, and other financial records.
- Common models include the FICO score and the VantageScore, which weigh factors like payment history and credit utilization.
Definition
Section titled “Definition”Credit scoring is a system used by financial institutions to evaluate the creditworthiness of an individual. It assigns a score that reflects the likelihood a borrower will be able to repay a loan, based on a variety of factors including credit history, credit utilization, and other financial metrics.
Explanation
Section titled “Explanation”Credit scoring models use multiple data points — for example, information from credit reports, bank statements, and other financial records — to calculate an individual’s credit score. Lenders use that score to decide whether to extend credit and, if so, at what interest rate. Individuals can use their score to understand their creditworthiness and take steps to improve it.
Examples
Section titled “Examples”FICO score
Section titled “FICO score”The FICO score is a widely used credit scoring model in the United States. It is based on five factors: payment history, credit utilization, length of credit history, new credit, and credit mix. Payment history accounts for 35% of the FICO score, and credit utilization accounts for 30%.
VantageScore
Section titled “VantageScore”The VantageScore was developed by the three major credit bureaus (Equifax, Experian, and TransUnion). It uses a similar set of factors to the FICO score but places more emphasis on recent credit behavior and includes additional data points such as rental payments and utility bills.
Use cases
Section titled “Use cases”- Lenders use credit scores to determine whether to extend credit and to set interest rates.
- Individuals use credit scores to understand their creditworthiness and identify actions to improve their score.
Notes or pitfalls
Section titled “Notes or pitfalls”- In the FICO model, payment history is the most important factor (35%) and credit utilization is the second most important (30%).
- Credit scoring models rely on a variety of data points; different models may emphasize different information (for example, recent behavior or additional records like rental payments).
Related terms
Section titled “Related terms”- FICO score
- VantageScore
- Credit report
- Bank statements
- Credit utilization
- Rental payments
- Utility bills