Thursday, November 18, 2010

Your Credit Score Is a Ranking, Not a Score (Cleveland Fed)

Credit scores are used in nearly every part of our lives, from applications for car loans, mortgages, credit cards, and car insurance to even some hiring decisions. It is well established that people with higher scores get better loans, have better jobs, and pay lower insurance premiums than people with lower scores. Because credit scores matter so much, many consumers regularly monitor their scores, and some try to improve them. But when people start paying closer attention, they are often puzzled by how and why their scores change over time.

Credit scores can be hard to figure out. They can change even when one’s behavior has not. Or the same exact credit score can qualify a borrower for a loan one year but not be high enough the next. Part of the apparent unpredictability comes from the common misunderstanding that a credit score is a rating of one’s creditworthiness. Actually, it is a ranking of one’s creditworthiness compared to the rest of the population in the United States at any point in time. In other words, your score depends not only on your credit behavior but also on the behavior of others. If your score changes over time, it means your rank-order among other consumers has changed.

Knowing more about who produces credit scores and how they are calculated can help consumers understand, interpret, and manage their scores. So read on:

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