Credit Rating and Its Management

Executive Summary

The purpose of this document is to outline the management of a credit rating. A credit score is a number between 300 and 850 that is assigned to a consumer using a numerical formula. Things that go into this formula include many parts of a consumer's financial history, including, but not limited to: your payment history, the amount that you owe, the length of your credit history, how recently you applied for credit and the type of credit that is used.

This document explains the history of the credit score and how it came to exist. The credit score is calculated by the Fair Isaac Company, and is better known as a consumer's FICO score. This company is used for its consistency and accuracy.

Understanding this score and the factors that go into can help a consumer to improve and maintain their score, leading to thousands of saved dollars through better interest rates. It is important to use credit to plan for future purchases that will be financed through loans.

The importance of a credit score in relation to insurance premiums will be discussed, in addition to the importance that bankruptcy can have on a score.

This document also outlines the steps that can be taken to improve your score, both in the long run and in two months.

The credit score is a three digit number that can shape one's financial future and have the deciding factor in the ability to receive good rates and save money in the future. It is a numerical expression based on the statistical analysis of a person's credit history that is used to measure their creditworthiness.

The concept of credit rating has been around for many decades, but a universally effective formula was not widely used until the early 1970s. The Fair Isaac Company created the formula and the introduced new legislation into congress that passed in 1971 called the "Fair Credit Reporting Act." This legislation required positive information to be added to the credit report, and required consumer ability to view the entirety of the report once a year for free to dispute errors, while many new privacy rules were also added.

Prior to the passing of the Fair Credit Reporting Act, intimate details of people's lives such as drinking habits, sexual orientation, and health were recorded from such sources as news papers and word of mouth gossip. The early credit reports existed solely for the benefit of creditors and lenders, and the citizen who was being reported on had no right to view or know anything about what was on their credit report. As credit bureaus became larger and information became much easier to transmit across the country, the influence on and importance of the credit report became much greater to the average citizen.

Ever since this mathematical formula to judge credibility was pioneered by engineers Bill Fair and Earl Isaac in the 1970s, it has been used by major lenders all over the world. One of the reasons that the formula developed by Fair and Isaac became so popular was the fact that it was the first credit bureau-based scoring system which took advantage of the extremely large Equifax, Experian, and TransUnion lending databases. Before this formula was introduced, each company had their own credit-scoring formulas that were customized based on the individual company's room for risk and different customer based. The problems arose when most companies did not have large enough databases to adequately predict risk in lending and this new formula introduced by the Fair Isaac and Company solved the problem. The new formula gained large amounts of popularity throughout the 1980s and 1990s because it took into account the behavior of millions of borrowers, evaluated consumers history of paying bills, showed how much available credit the customer was using, and calculated the likeliness of borrower paying off the lender as agreed.

With the popularity of this new and effective formula came a huge spike in the amount of credit people were using. The number of consumer loans more than doubled between the years of 1990 and 2000. Many have said that the increase in the use of credit could be a direct result of the credit scoring system. The subprime lenders were able to charge borrowers with lower credit scores a higher interest rate, which was good for their business but caused a lot more debt problems. Credit scoring also received a boost in 1995 when Fannie Mae and Freddie Mac recommended the use of FICO scores to major lenders.

A credit score decides many items through the financial future of one's life. Many people do not realize the importance until it is too late and when applying for a loan, think back and wish their score was higher and was managed better from the start. It takes a responsible consumer to be aware of this and to be able to make on time payments and budget funds accordingly.

Credit scoring systems are useful in many ways. They can detect fraud and calculate the amount of profit a credit card issuer is likely to make on a particular account. Credit scoring systems can also predict the risk of a specific kind of default, such as bankruptcy, which is on your credit report for seven years. They can also forecast the probability that a policy holder will cost their insurer money and they can estimate how much a borrower is likely to pay on a delinquent account. These credit scoring systems also anticipate which customers might close credit card accounts and which consumers will pay the balance down to zero. Lastly, credit scoring systems can also predict the likelihood that someone will respond to credit card solicitation.

Understanding the formula and the way that credit scoring companies like FICO operate can be the first step to improving your score or establishing one on the right foot. Consumers have to be aware that your score is constantly changing. Each day, new information is being added and old information is being taken away. Your score fluctuates in a certain range. This can be a good tool. If a consumer currently has a bad score, he or she is not stuck with it forever. There are ways to improve a score and there are items that can bring your score down too. Knowing these factors and the role and weight each factor contributes to the formula is the first step.

FICO, like many credit score reporting companies does not want consumers to know the secret to predicting trends or they would not be useful to lenders and credit bureaus. There is enough information, however, to know what helps and what hurts your score. To have a credit score, you must have and use a credit card and you need an account that has been open for at least six months. When purchasing a house or a car this score can help you get a lower rate, but this score is not the only thing

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