A credit score can make -- or break -- a would-be borrower
By Michael D. Larson

Most people would argue that computers and technology have made consumers' financial lives easier. Need to check account balances, trade a stock or apply for a card online? No problem, thanks to the Internet.

But the impact of those advances pales in the face of the effect of the credit score, perhaps the most important technological advance of all for the countless Americans who try to borrow money every day.

Brand or halo
Indeed, credit scores can be the scarlet letter or golden halo that follows people around from the day they get a credit card to the day they send in their last mortgage payment, largely because they affect an overwhelming number of today's lending decisions.

Named for credit scoring industry leader Fair, Isaac and Co., the FICO score is derived in part from a borrower's past credit history, says David Shellenberger, product manager for the company's credit bureau products. The company's software and services take that history and measure it against a database of habits in the general borrowing population. That, in turn, determines whether the borrower's tendencies match those of borrowers who default on debt, declare bankruptcy or end up in other types of financial trouble.

"Everything is relative," Shellenberger quips.

Five things count
When determining how high a score will be, five characteristics separate the cream of the crop from everyone else. In descending order, they are:

• Past delinquency. People who have failed to make payments in the past tend to do the same in the future.
• The way credit has been used. Someone maxed out or close to the limit on a credit card is considered a greater risk than someone who doesn't look at the high credit line as a license to print money.
• The age of the credit file. Fair, Isaac's model assumes people who have had credit for a long time are less risky.
• The number of times a person asks for credit. The systems frown upon those who have initiated several requests for credit cards, loans or other debt instruments over a short period of time.
• A customer's mix of credit. Someone with only a secured credit card is generally riskier than someone who has a combination of installment and revolving loans. (On installment loans, a person borrows money once and makes fixed payments until the balance is gone, while revolving borrowers make regular payments, each of which frees up more money to access.)

The Fair, Isaac system looks for patterns, and takes into account when a problem occurred and whether it is part of an ongoing problem.

"Credit scores are compensatory in nature," Shellenberger explains. "Let's say that you're a borrower and you may have had a charge-off in your credit file. If that charge-off happened, maybe, several years ago, and you've been able to maintain your credit over that period of time, that person is going to be judged differently from someone who just had a charge-off, maybe, six months ago."

Defining a good score
Once all the data is gathered, the system spits out a number roughly between 300 and 800. Anything higher than 660, and it's time to breathe a sigh of relief, everything's fine. Falling between 620 and 660 isn't bad either; it may just take more work to convince the lender that the risk is worth it. Below 620, however, and it's no man's land. There's still a shot at obtaining a loan, but it's a long one.
Freddie Mac, a quasi-governmental agency that sets standards most mortgage lenders follow, says exceptions might be made if the credit report has incorrect or incomplete information in it, or if it doesn't contain enough data. An unusual event such as a job loss or extended sickness may excuse borrowers as well, according to the agency.

How scores are used
Mortgage lenders typically take a score and consider it in light of, among other things, a home's price, the applicant's income and the percentage of that paycheck a monthly house payment would swallow.

But lenders are only one of the mortgage industry groups that scrutinize credit scores. Private mortgage insurance companies use the score to assess their risk before dealing with a customer who does not have enough money for a full 20 percent down payment. Mortgage servicers, who may take over the day-to-day operations of the mortgage, sometimes use those scores, too, in order to figure out which customers are likely to default and who might stay clear of foreclosure if a new payment plan were offered.

On the lender side, both Freddie Mac and Fannie Mae buy mortgages from lenders, bundle them as securities and sell them to investment firms. Those firms depend on either staff analysts or outside rating agencies that use credit scores to assess the securities' risk.

"One of the nice things about credit bureau scores, because they are available through credit repositories, is that they are accessible to everyone in the mortgage finance chain," Shellenberger says. "From community banks, wholesale lenders and large mortgage bankers, all the way up to ratings agencies and investors, it provides a common benchmark."

Scores mean different things to different people
Other industries use the generic scores as well, and customize them with their own variables. Credit card lenders, for instance, place additional weight on credit card-related information, such as how many times a person missed revolving credit payments. And the systems evaluate a college student being targeted for a starter card differently than a stockbroker with a summer home in the Hamptons, who might receive offers of a platinum card.

Auto scores, on the other hand, focus on "deal characteristics" in much the same way the mortgage scores do, Shellenberger says. They take into account things such as the amount a customer puts down, for example, as well as a borrower's debt-to-income ratio, length of time at one job and the like. As with credit card lending, information about past performance on similar types of loans is weighted, so a missed Nissan payment might be more important than an overdue Visa bill.