How credit scoring works.
by David B. Leidy

Credit scores are part of the lending decision. What do lenders look at when deciding whether to approve a loan? Typically, lenders making almost any kind of credit decision will look at a variety of types of information, including one or more credit scores. While there are many kinds of credit scores, the most frequently used are credit bureau risk scores developed by Fair, Isaac.

What is a Credit Score?
A score is a number that tells a lender how likely an individual is to repay a loan, or make credit payments on time. When a lender requests a credit report and score from a credit reporting agency, the score is calculated by a "scorecard" or scoring model - a mathematical equation that evaluates many types of information from your credit report at that agency. By comparing this information to the patterns in thousands of past credit reports, scoring identifies your level of credit risk.

How the Score is Used
A score takes into consideration five categories of information, not just one or two. No one piece of information or factor will determine your score. The five categories are:

• Payment History. What is your track record? (Approx. 35% of your score)
• Amounts Owed. How much is too much? (Approx. 30% of your score)
• Length of Credit History. How established is yours? (Approx. 15% of your score)
• New Credit. Are you taking on more debt? (Approx. 10% of your score)
• Types of Credit in Use. Is it a "healthy" mix? (Approx. 10% of your score)

Additional Score Reason Codes
When a lender receives your Fair, Isaac credit bureau risk score, up to four "score reason codes" are also delivered. These explain the top reasons why your score was not higher. They say things like "Number of accounts with delinquency." If the lender rejects your request for credit, these reason codes can help the lender tell you why your score wasn't higher.

These reason codes are more helpful than the score itself in helping you determine whether your credit report might contain errors, and how you might improve your score over time. However, if you already have a high score (for example, in the mid-700s) some of the reason codes may not be very helpful, as they may be marginal factors related to the last three categories above.

For further information on credit scoring, read How to Improve Your Score.