Not All Credit Scoring Models Are Created Equal

Finding a first-time homebuyer, who actually has the necessary credit score to qualify for a mortgage, is becoming more difficult by the day. According to a study published by the Federal Reserve Bank of New York, more than one-third of Americans have a credit score below 620. What is even more alarming is the CFPB’s study that found in addition to those with poor credit, there are another 45 million adults who are either un-scoreable or who do not even have a credit score.

As consumers try to deal with their credit challenges, they are being bombarded with messages about their credit scores from many different sources.  Some of these companies have even created simulated scores which many consumers find misleading and confusing, especially those who rely on those scores when seeking out financing for a new home.

Credit Karma is one example of a company that generates scores using the Vantage scoring model (Vantage score 3.0).  Consumers frequently rely on the scores that are generated by this and similar companies before they apply for home or auto financing, only to find out that lending institution utilizes credit reports and scores that were generated from a completely different scoring model. Many people are often surprised to learn that their actual credit score is drastically different from the generated score they received online.  One reason for this is that many simulated or alternative scoring models don’t take the same information into account as the reports on which lenders rely. 

Consumer Example of conflicting credit scores: Potential borrower contacts lender and has lines of credit but DOES NOT show a score.  However, when the potential borrower pulled his credit off a website for free, he had a score in the mid-700’s.  

His specific report pulled by the lender shows NO PAYMENT FOR 8 years.

The simulated or alternative model could be basing it on the positive payment history, were as the repositories are basing it on current activity.  A FICO Credit Score is a snapshot of what is going on today.  Over the last 8 years, nothing has been going on.  Therefore, no scores appear for this potential borrower. 

Can you picture the confusions and frustration when the lender tries to explain that this borrower doesn’t have a credit score?

It is also important to confirm that your personal information is correct with the bureaus as sometimes information is pulled in and/or NOT pulled into your report.  If something doesn’t report, it’s not included into your FICO score.   

Therefore, It is critical to help consumers understand that not all credit scores are created equal, especially as it relates to obtaining financing for home ownership.

Here is a brief overview of different credit scoring models, the differences between actual and simulated credit scores, and the importance of knowing your actual consumer credit scores. 

FICO v. Vantage

The FICO score is a score that was formulated to evaluate creditworthiness. It is promulgated by Fair Isaac Corporation and was first utilized by lenders in 1989.  Your FICO score is calculated based upon the following five factors: 1) Payment history, 2) Credit utilization ratio, 3) Length of credit history, 4) New credit accounts, and 5) Credit mix. 

In 2006, to compete with FICO, the three major credit bureaus developed the Vantage scoring model. This model calculates credit scores using some of the same factors as FICO, but also incorporates some additional information. The Vantage factors include: 1) Payment history, 2) Credit age and mix, 3) Credit utilization, 4) Balances, 5) Recent credit applications, and 6) Available credit. Although Vantage has been making a push in recent years, FICO scores remain the industry standard across various financial sectors for evaluating consumer credit worthiness.  

Actual v. Simulated

It is important to note the difference between actual credit scores and simulated credit scores. There are many websites, such as Credit Karma, that purport to provide consumer credit scores for free. However, consumers should be weary of putting too much credence or relying too heavily on those scores.  

A simulated score is calculated based upon actual information in a consumer credit report, but it may not necessarily reflect your true credit score, which is promulgated by the FICO or Vantage models. There are many instances in which consumers review their simulated scores prior to applying for loan or other financial product, only to find out later that they do not qualify because their actual score is lower than the simulated score. 

Importance of Getting Actual FICO Score

According to FICO, 90 percent of “top” US lenders use FICO scores when evaluating the credit worthiness of applicants. As the predominant scoring model in the US, consumer FICO scores will, more often than not, determine whether a consumer will qualify for the loan or financial product for which he or she is applying. It is imperative that consumers keep this at the forefront of their minds when devising a strategy or making a decision about when and whether they should apply for a mortgage or a car loan. 

Whenever a consumer applies for financing, and the potential lender makes a hard inquiry (pulls the consumer’s credit), that consumer’s credit score is negatively impacted, and will decrease as a result of that inquiry. If a consumer believes that he or she will qualify based upon the simulated score, but is later denied, their credit score will take a hit unnecessarily. 

Because of the deleterious effect that hard credit inquiries have on a consumer’s credit profile, it is imperative that consumers know their actual credit score prior to applying for loans. There are companies that offer monthly subscriptions, which include actual consumer FICO scores that are updated monthly. This type of service is invaluable for those who are serious about achieving and maintain credit health, and eliminating any guesswork when applying for loans.

In addition to accessing actual credit score, here are some ways in which consumers can build and/or improve their credit profile.

Two quick way’s to create a score:

Start using a credit card, if you don’t already. Using a credit card and paying it on time every month is a great way to begin establishing credit history.

For those accounts that are open, make sure to use them periodically.  If you don’t use them, the creditor might close the account down which could have a negative impact on credit score.  

Why do these two ways impact ones credit:

30% affects Utilization. It is best to have several accounts with low balances distributed then it is to have fewer accounts maxed out. To figure utilization: Balance (divided) by Credit Limit = percentage. Lower than 10% recommended per account, this is one of the fastest means for increasing the over all credit score.

15% affects Established History. The longer you maintain open accounts with creditors the better. When first starting out of course this is not easy; but this is where getting added as an Authorized User to another persons established credit comes in best. Remember that the contributor must have an account that has long history; clean payment record; high credit limit, and low balance. Also need to check with the creditor to insure that they have a policy to report authorized user accounts to all three major credit-reporting agencies. Anther great option is getting a secured credit card that reports to all three bureaus.  Try to find options for secured credit cards that do not require to pull credit. 

SPECIAL NOTE to quickly build accounts: Authorized user accounts are the best way to go; since you are not legally responsible for the debt rather than Joint or Co-Signer accounts. Also, if this account starts to report negatively; these accounts are usually easier to remove from the credit reports by either contacting the creditor or requesting termination of the relationship; or disputing through the CRAs.Just because you can pull a score off the Internet does not mean that it is the score that a lender will use to qualify you for home financing.  Remember, not all credit scoring model are the same, especially as it relates to the mortgage industry.