The recent downturn in the economy has made life difficult. People have lost their homes to foreclosure. Bankruptcies are at a record high as people struggle with mounting credit card debt. They may make only minimum payments on their debts and some of those payments are made late. As a result, lenders are more cautious about who they lend money to.
There is an awareness of credit scores that did not exist in the past. You only have to log on to the Internet to have a pop-up ad offer you your current credit score for free. What does all this mean?
There are three major credit reporting companies: Equifax, Experian and TransUnion. They all use FICO and VantageScores to determine if you can get a loan. What are FICO Scores and VantageScores and what is the difference between them?
What is a FICO Score?
When you apply for any type of loan, whether it is for a car loan, credit card, furniture or mortgage, lenders want to know whether or not they can trust you to pay back the money they loan you. In 1956, the Fair Isaac Corporation developed a scoring procedure, now called FICO.
There are three credit reporting agencies that calculate your FICO score based on five different categories. The score ranges from 300 to 850. The higher your score, the better your credit is. This is important for many reasons. Lower scores may not even qualify for a loan.
Interest rates are lower for those with higher FICO scores. For example, you may see ads for automobiles that advertise no down payment and low monthly payments. If you look at the small print, you will see that the bargain is only offered to those with high FICO scores.
Some categories are more important than others. The categories are as follows.
- Your payment history makes up 35 percent of your score. If you have a history of making late payments on any loan, your credit score goes down. This is essentially the most important part of the FICO score.
- How much money you owe makes up 30 percent of your score. Lenders want to be sure you are not overextended and will be able to make your monthly payments.
- Length of your credit history accounts for 15 percent of your score. This means accounts that have been open longer with a good payback record give you a better score than an account that was just opened.
- Types of credit accounts you have makes up 10 percent of your score. This analyzes credit card debt, mortgage loans, any installment payment plans or any other loan you may have.
- New credit accounts for 10 percent of your score. Opening up several new accounts will lower your score whereas having long term accounts raises your score.
Your FICO score is determined after the company analyzes the above information. A mathematical formula is used to come up with the assigned score. One problem is that each credit reporting agency may come up with a different FICO score.
What is a VantageScore and how is it different from a FICO score.
VantageScore was developed in 2006 by the three credit reporting agencies. It has advantages for people who do not use credit very often. While FICO scores may differ from one reporting agency to another, the VantageScore is supposed to be the same across all three reporting agencies. A VantageScore ranges from 501 to 990 and, like the FICO score, the higher the number the better the credit rating is.
VantageScores take into account some of the same factors as the FICO, such as credit history, length of time the account has been open, amount of credit being used and whether payments have been made on time. VantageScore values each factor on its own merit. It imposes a higher penalty on late mortgage payments than other late payments, while FICO treats all late payments the same.
VantageScore expects to be able to give better scores to those who have had credit problems in the past. The company evaluates those with a shorter credit history than FICO and scores past bankruptcies better.