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Kaitlyn McCoy

Professor Cassel

English 1201

04 November 2021

Dissecting the Credit Scoring Model

There is the golden rule and then there are the golden numbers. Your credit scores are the

golden numbers. They shape your financial future and there’s not much you can do about it. My

parents had to find this out the hard way. Young adults having three children back-to-back-to-

back can never be an easy situation especially without family members having enough income to

help. My parents had to live paycheck to paycheck and even that wasn’t enough for the

overwhelming amount of bills plus necessities of a five-person family. Every time a bill was late,

or a car had to be repossessed their credit scores took hit after hit. Over the years they have

climbed out of poverty and into a comfortable lifestyle except they can’t erase the storm clouds

they call their credit scores. Hardships and bad credit set my parents up to never be able to own a

home or buy a car without paying double by the end of the loan.  So, what exactly are credit

scores, how are they determined, and why the heck does it matter? People write entire novels and

textbooks on this topic because there is no easy answer. Credit scores are determined by many

different factors inside a complex algorithm and have a major importance to everyone to

discover more about their loans, interest rates, where they can live, and other various financial

needs.

Credit scoring has evolved tremendously since it was developed less than a century ago.

In the 1950’s, the earliest credit reporting companies were local, small, and focused on keeping
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track of customer delinquencies at retail stores. Since regulations on these companies did not

exist, they could scour newspapers to use arrest and marriage records, race, and social status

against consumers (Furletti). Bill Fair and Earl Isaac founded FICO in 1956, which became the

first institution to standardize credit scores by the 1980’s (Weston). The Fair Credit Reporting

Act of 1970, or FCRA, was created by Congress to regulate the companies reporting these scores

because of the unfair and unjust acts they had been committing (Shweta et al.). The FCRA

established many consumer rights including being informed if their information is used against

them, the right to dispute inaccurate statements, and required consent for employers to access

employee’s credit information (Furletti). By the year 2001, FICO scores became available to the

public and has since been the foundation for financial risk assessments (Hagler). With these tools

in place, people are now being judged better than in the past because of algorithm and laws

replacing the prejudice.

Credit scores are numbers that represent creditworthiness, which is essentially a

judgement of someone’s ability to pay off debts. FICO scoring is a compilation of the

independent credit scores created by the three major US credit reporting agencies. These

agencies are Equifax, Experian, and TransUnion and they all have different methods for creating

their scores (Davenport and Rudy 6). For example, Equifax reports at different times and more

frequently than Experian. Some lenders may not report to one of the bureaus and it is crucial to

make note of each difference when obtaining copies of these scores. Different scores lead to

confusion and people will be surprised when they check one score but then get declined for a

loan based on a different score. When people talk about good credit or bad credit, they’re

referring to the range a person’s scores fall into. Credit scores range from 300 to 850 with 300

being the worst and 850 being the best. The range of 300-600 is considered poor credit, 601-660
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is considered fair, 661-780 is considered good, and 781-850 is considered excellent (Weston).

Many experts use various ranges, but they all closely relate to Weston’s. High scores mean low

risk to lenders and vice versa. According to Experian, the average credit score in America is 710.

People have placed such a strong importance on these numbers that some dating websites aim to

match people based on their credit scores. Great difficulty comes with navigating the dating

world, but credit scoring computation is much harder.

A complex algorithm is
Credit Scoring Factors
used to compute these scores using
10%
10% 30% a variety of factors. FICO keeps the
15% specifics of their algorithm a secret,
35% but experts have been able to drill

down what factors go into it. These

Outstanding Debt Payment History
Length of Credit History New Credit Inquiries include outstanding debt, payment
Variety of Accounts
history, average age of credit, and

the number of total accounts

(Hagler). Outstanding debt and payment history alone make up for 65 percent of the total scores

with payment history being the most significant piece (Davenport and Rudy 17). Length of credit

Figure 1. This chart shows the proportions of history accounts for approximately 15 percent of
different factors that determine credit scores.
Created by Kaitlyn McCoy. the scores and is calculated by finding the sum of

the ages of all open accounts divided by the total

number of accounts (Weston). The types and number of accounts has a smaller, but still

meaningful effect on credit score computation so most finance professionals recommend

multiple revolving accounts such as credit cards, and at least one installment account such as a
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mortgage (Davenport and Rudy 23). Hard inquiries also factor into this algorithm. When a

person is shopping around for additional loans or credit cards, the lender will do a hard inquiry

on their credit scores, which will temporarily lower scores (Furletti). People looking to open

another account are seen to be riskier than those who aren’t, and thus hard inquiries have a

negative impact. There are countless other tiny factors that go into computing these scores, but

these are the ones with a noticeable impact. After learning how scores are determined, it is easier

to strategize ways to improve them.

Many people have come up with tips and tricks for beating the system and raising these

scores quickly. These tips include overpaying on loans, paying balances in full before creditors

do their monthly report, and politely threatening to switch lenders if interest rates go up

(Weston). Overpaying on loans means that they will be paid off quicker and therefor a portion of

the interest is avoided. If the loan is paid off in adequate timing, this event will have a positive

impact on that person’s scores. If credit card balances are paid in full before creditors do their

reporting, then that person’s outstanding debt would be significantly lower than if they had

waited for the mandatory payment date (Weston). Paying balances in full is also another method

of reducing interest since interest on credit cards is only due if the balance is paid in installments.

Due to competition from so many lenders, companies have started issuing individual rates to

customers who threaten to leave over rising interest (Furletti). Regardless of all the tricks in the

world, the most consistent method of raising a credit score is keeping up on payments while

having a decent average age of credit and keeping many accounts to spread balances across.

When a person applies for any type of loan, the lender looks at one or all three of their

credit scores to determine approval and interest rates. Interest rates are usually expressed as an

annual percentage rate that appears on every type of loan. These rates vary greatly and are based
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on the type of loan as well as the applicant’s credit (Weston). For example, Sally, who pays all

her bills on time and has never defaulted on a loan, would have a higher credit score than Greg

whose payments are always late. Sally would be approved for more loans with lower interest

rates than Greg, which means more money in her pocket for other things. Low interest from a

good score yielding lower payments will help to buy necessities such as groceries while

maintaining an emergency fund (O’Shea). If Greg’s payment was $200 higher than Sally’s, he

would be much worse off than her even though they have the same loan and the same income all

due to interest from credit scores. An emergency fund is crucial to make sure that unexpected

costs can be covered while not dipping into bill money and making late payments. The average

person with an excellent credit score will save $60,000 in interest compared to someone with fair

credit from car loans, mortgages, etc. (Hagler). That is a lot of money that someone could save or

pay based on a few numbers and therefor it is important to be educated on and familiar with how

this all works. Educating oneself can be challenging with the amount of misinformation

circulating online.

Myths about credit scoring are as old as credit scoring itself. False information used to be

spread by mouth and considered to be gossip in the economist world. Since then, the online web

and social media have been catalysts for false information and promises to gain higher scores.

The biggest myth of all is that closing accounts will always increase scores. This is false because

closing accounts will make a person’s average age of credit shorter since the age of the closed

account will no longer be taken into consideration. Closing an account can also increase

available credit to debt ratios which will lower scores and raise flags (Weston)(O’Shea). The

second biggest myth is that checking in on scores will harm them. Many credible sources, such

as Gina Hagler, stress that this idea is false since the FICO scoring model ignores the inquiries
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generated from checking one’s own credit scores. These are called soft inquires and do not show

up in the credit reports. In fact, the FCRA guarantees one free yearly report from all three credit

reporting agencies (Hagler). Many also believe that credit counseling may be worse than filing

for bankruptcy. This idea cannot be further from the truth because bankruptcy is the atomic

bomb of credit scores. Credit counseling does far less harm by setting up structured payments to

pay off debts while bankruptcy writes off those debts (Weston). With all of these myths and

rumors, it can be hard to keep the facts straight when credit scoring is already complex as it is.

The average person knows good credit is needed to get approval on mortgage loans, but

some do not realize that even landlords can use credit as a determining factor for renters.

Nothing is more discouraging than getting denied for a mortgage and even getting rejected as a

renter, yet it happens all the time. Just as lenders do, landlords can base a person’s ability to pay

rent on their credit scores and see potential evictions in those with poor credit (O’Shea). Renters

also get a bad reputation due to the assumption that they rent because their credit scores are too

poor for a mortgage (Weston). Some renters choose to rent simply because there is no long-term

commitment, but the assumption of poor credit is true for most. It is significantly more expensive

to rent than to pay a mortgage which leaves less room for savings and higher chances of staying

in the poor credit range.

Most people strive for excellent credit, but many feel those numbers are out of reach due

to income restrictions, impulses, and bad loan decisions from their past (Shweta et al.). Impulses

occur frequently in this fast-paced world because everything goes in and out of style so quickly

along with new technologies always being discovered. Many have experienced a fear of missing

out and purchase things that they know they cannot afford. Bad debt can affect a person’s credit

scores for 7 years before falling off which is plenty of time to do damage (Hulya et al.). Income
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restrictions are the most disheartening of all credit issues because if someone doesn’t have the

money, they just don’t have the money. There are numerous people living in situations where

they must choose between food and rent or electricity and car payments. These clearly are not

easy decisions and no matter what is chosen their credit and overall wellbeing are affected. When

the debt starts to rack up, most people don’t have the income to dig themselves out of the hole

and must ask relatives for help (Davenport and Rudy 177). What if their relatives are in the same

boat?

When a person has accumulated so much debt that they cannot overcome it and no

relatives are able to help, they must consider either filing for bankruptcy or going through credit

counseling. As stated from Weston previously, filing bankruptcy is the atomic bomb on a

person’s credit score and should be avoided if possible. Credit counselor Anthony Davenport

puts it in his book Your Score on page 178 as “…an announcement to creditors that you have

given up, and you won’t be paying them back…” which is an excellent way to say it. This makes

future creditors not even want to deal with that person. It is wise to first consider credit

counseling to have reasonable payments set up and is often referred to as debt management.

Credit counseling itself will not affect scores but enrolling in the debt management plan will

since a portion of the original payment was not received on time (Hulya et al.). Some lenders

view debt management in the same light as a Chapter 13 bankruptcy although they have

differences. Both options make a person pay their debts, but credit counseling only appears on

credit reports if the person is still paying on the plan (Weston). Any type of bankruptcy stays on

that person’s credit reports for 10 years no matter if the debt was paid in installments or not paid

at all. A Chapter 13 bankruptcy is an agreement to pay debts within three to five years and must

be presented before a judge (Hulya et al.). Within this payment plan the lenders most often take a
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person’s entire federal and state tax returns every year payment is still owed excluding any

credits such as the child dependent tax credit. A Chapter 7 bankruptcy wipes away all unsecured

debts which includes credit cards and repossessed vehicles but will not cover any government

student loans or taxes owed (Davenport and Rudy 178). In a Chapter 7, all assets of value must

be liquidated, meaning sold, towards the payment of debt excluding retirement funds (Weston).

A Chapter 13 is slightly more respected than a Chapter 7, but neither are ideal. Both types of

bankruptcy will put a person at the bottom of the credit scoring food chain and requires at least a

five-year credit recovery plan to avoid making the same mistakes again.

It is not uncommon for an account or two to be sent to collections throughout a person’s

adult life and it is important to know how to handle them. Collections is a process by which a 3rd

party buys bad debt from companies at a fraction of the cost and takes over the efforts to reach

those indebted to them (Davenport and Rudy 152). Collection companies operate differently

based on their style and preferences. Some debt collectors like to quietly sit with the debt and

watch credit scores plummet waiting on that cry of help to settle (Weston). Settling on a debt is

an agreement to pay a lesser amount than owed if it is paid in full upon approval from the

collection agency. This is an excellent resource, and it is encouraged for anyone experiencing

collections to always attempt a settlement before agreeing to pay the full balance (Weston).

Other more aggressive debt collectors will badger their victims with numerous phone calls and

letters in the mail demanding payment. These collection efforts can be intimidating and often

should be checked for accuracy because many will continue to harass people to pay debts that are

too old to matter. Unfortunately, when a borrower does get pressured into paying an eleven-year-

old debt there is nothing they can do because there is no law against paying off old debts
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(Davenport and Rudy 153). Collections accounts will severely hurt a person’s credit scores and it

is crucial to avoid them at all costs.

Now that it is clearly understood how credit scores can affect people in a negative way, it

is also just as important to know the good things that come from credit like credit card rewards.

Not only did the credit scoring model create fairness, but it also opened doors for those with high

scores to reap more benefits than before. Many credit card companies have cash-back rewards

and flight miles associated with the type of cards given to those with good credit (O’Shea). Cash-

back rewards involve lenders giving a certain percentage of a purchase amount back to the user

as an incentive for cardholders to use the accounts. Flight miles are like cash-back, but the

percentage is expressed as points for the cardholder to redeem for purchase of airline tickets at

little to no cost. These rewards come at no small fee. For example, cards like the American

Express Platinum charge upwards of $450 in annual fees (Clemence). These companies survive

and can charge these fees because the large barriers to entry for these cards creates an extremely

wealthy member pool that save much more in perks than they spend in annual fees. One of these

barriers to entry being high credit score requirements.

Another perk received from having good credit is the option of owning a home instead of

renting. The minimum score required for a conventional mortgage is 660 which is considered

good credit (Davenport and Rudy 85). A score of 660 will get that person approved for a

mortgage, but at a significantly higher interest rate than someone with a higher score. When a

person has access to lower interest rates, they will have the ability to purchase a more expensive

home for the same monthly payments as someone with a cheaper home paired with higher

interest. An example would be Sally and Greg both applying for a $400,000 mortgage. Since

they have the same income but different scores, Sally could be able to afford the home because
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the lower interest got her that lower payment while Greg may have to apply for a $325,000

mortgage instead to afford those high interest payments. Once a person owns their home, they

have home equity which is an important source of emergency funds because they can take out

other loans based on the value of their home (Weston). Everyone loves and appreciates a rainy-

day fund. Home ownership is most often the best feeling accomplishment in one’s adult life and

everyone should be able to experience what that feels like. Without good credit though, this is

quite impossible.

The final significant upper hand that good credit can give a person is the ability to retire

earlier. Because of all the ways that having good credit can save a person money, they are able to

have larger 401k accounts and retire earlier. A 401k is a retirement plan, usually through that

person’s employer, that is composed of paycheck and employer contributions (Crelin). Those

with early retirement often live longer because they have less stress and can focus more on their

health. When a person has mass amounts of debt, they often have taken money from their

retirement accounts to pay off debt collectors throughout time and cannot afford to retire until

they are in too bad of health to continue (Davenport and Rudy 183). These early payouts have

high tax penalties associated with them and taking $10,000 out now can lead to a $100,000 loss

in future growth (Crelin). It cannot be stressed enough the impact credit scores have on the

amount of money a person saves as well as their mental and physical health.

Credit scoring has a complex way of being determined and substantial importance to

everyone. Now it is easier to understand why there are entire books written on this topic because

there is so much ground to cover. This is just the tip of the iceberg with much more content

beneath the surface. Everything about someone’s financial wellbeing and future is dependent on

these three numbers which can make or break the bank. From the beginning of credit monitoring
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history, consumers are becoming more aware of the significance and impact of these numbers.

The problem that will always arise is income being the number one factor in determining the

likelihood of having high scores (Weston). No one wants to have bad credit or tries to have bad

credit, it’s just that income restrictions force decisions to be made on what bills to pay.

I wish that I could conclude that my parent’s situation could have been avoided if they

would’ve followed the suggestions found throughout my research, but income restrictions feel

like you have your hands tied behind your back. When you work full-time while never giving

yourself a break and you still fall short, there is a sense of feeling defeated by the system. Many,

including my parents, must resort to bankruptcy to wipe the slate clean and start a new

beginning. This new beginning, having a credit score atomic bomb attached to it, feels like yet

another loss. It feels as if the algorithm, the system, and the lenders set those in poverty up for

failure while the rich are rewarded for having the ability to pay all expenses on time.
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Works Cited

Clemence, Sara. “The Quarantine Guide to Points and Miles.” Bloomberg.Com, Apr. 2020, p.

N.PAG. EBSCOhost.

Crelin, Joy. “401(K).” Salem Press Encyclopedia, 2019. EBSCOhost.

Davenport, Anthony, and Matthew Rudy. “Your Score: An Insider's Secrets to Understanding,

Controlling, and Protecting Your Credit Score”. Houghton Mifflin Harcourt, 2018.

Furletti, Mark. “An Overview and History of Credit Reporting.” Philadelphiafed.org, Payment

Cards Center of the Federal Reserve Bank of Philadelphia, June 2002,

https://www.philadelphiafed.org/-/media/frbp/assets/consumer-finance/discussion-

papers/creditreportinghistory_062002.pdf?

la=en&hash=D1381DA9DD42EF5E7C574FF7213AE0EF. Accessed 05 Nov. 2021.

Hagler, Gina, MBA. “Credit Score.” Salem Press Encyclopedia, 2020. EBSCOhost.

Hulya, Eraslan, et al. “An Anatomy of U.S. Personal Bankruptcy under Chapter 13.” Staff

Reports, 2016. EBSCOhost.

Kumok, Zina. “Credit Score Charts: Data & Trends in 2021.” BadCredit.org, 21 Dec. 2020,

https://www.badcredit.org/how-to/credit-score-charts/. Accessed 07 Nov. 2021.

O’Shea, Bev of NerdWallet. “Why Good Credit Matters - Even If You Don’t Plan to Borrow.”

Canadian Press. EBSCOhost.

Shweta Arya, et al. “Anatomy of the credit score”, Journal of Economic Behavior &

Organization, Volume 95, 2013, Pages 175-185, ISSN 0167-2681,

https://doi.org/10.1016/j.jebo.2011.05.005. Accessed 03 Nov. 2021.

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Weston, Liz Pulliam. “Your Credit Score: How to Improve the 3-Digit Number That Shapes

Your Financial Future”. 5th ed., Pearson, 2015.