Buzz kill…Here’s Why Your Credit Score is Meaningless to Lenders

700, 680, 545…we’re all focused on our credit scores and with good reason. Credit scores can determine whether or not we can get credit to buy a home, a car, an education.  Credit scores can determine what kind of rates and terms we’ll get from lenders. Credit scores can determine whether or not we can get homeowner or auto insurance and at what premiums. Credit scores can even determine……if we’ll be required to pay deposits at apartment complexes and with public utilities. NOTE: Notice I didn’t include “get a job” in that list!

Still, while both FICO’s and VantageScore’s latest scoring models range from 300 to 850 I’d argue that your credit score is meaningless and irrelevant. No lender cares that you’re an 800 FICO or a 744 VantageScore. No credit card issuer cares that your FICO Bankcard score is 725 or if your VantageScore is 820. The actual number is 100% meaningless and irrelevant. What IS important, however, is the interpretation of those numbers. Follow me…

The numeric credit score itself doesn’t really have any value. It’s just the sum of points your credit report has earned across a variety of characteristics. It’s like a complex math problem that once solved you look at it and think, “now what?”

When a lender buys your credit score from a credit reporting agency they don’t simply look at it and say, “Hey, Ulzheimer’s FICO score is 750…I think we should approve him and give him a 5% interest rate.”  If they did they wouldn’t be in business very long. That type of arbitrary decision simply doesn’t exist in lending, insurance underwriting or utilities.

Each of your scores has what’s referred to as an “odds expectation.” Think of it like flipping a coin. Two sides, one flip…chances are 50/50 that you’ll land it on either side. Now apply that to credit scores and applicants. 750, odds are 1 in “something” this applicant is going to go seriously delinquent on anything in the next 24 months. THAT’S what’s so important about a credit score…the odds expectation.

Now, figuring out the “odds to score relationship” isn’t easy. And, it’s not done for you (unless you pay someone to do it for you). The score “user” is responsible for figuring out the odds on their own. For example, and I stress that this is simply an example, the odds you experience as a lender by FICO score range could look like this…

800+ = 1:1800

750-799 = 1:1000

700-749 = 1:500

650-699 = 1:100

600-649 = 1:20

550-599 = 1:3

<550 = 2:1

The first set of numbers represents the FICO or VantageScore range.  You’ll fall into one of those ranges when your score is calculated. That’s a guarantee.

The second set of numbers represents the number of “bads” to the number of “goods.” So in the 800+ range this hypothetical lender is realizing 1 bad to every 1,800 goods that apply with them for some fictional loan product. Those are great odds!  That’s why people that have scores that high get great deals.

As the score ranges drop the odds get worse for the lender, which means the deals get worse for the consumer…and rightfully so. The lender has to make enough money off of the “goods” in any score range to offset the amount they’re going to lose on a “bad” in that same range. Fewer goods to offset the loss caused by bads means you have to charge higher rates to everyone in that group.

Also, you may have noticed in the <550 range there are actually 2 bads to every 1 good in the range. Low score ranges mean horrible odds to the lender, which means horrible deals to the applicants. While my example above is just that, an example, it is very true that the bads to good odds get better as the score ranges get higher. If they do NOT then your scoring model isn’t performing well.

Do you know what your credit report or credit score looks like ? Visit here to see your updated credit report and credit score online now.

The score is simply a number, a value. That’s it. You could have a credit score scaled from A-Z, 1-1,000,000…or whatever you like. The value isn’t important. What the value means is what’s important.

JRU on 60 Mins SetCredit Reporting Expert, John Ulzheimer, is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  Follow him on Twitter here.

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