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Credit scores are provided by three primary credit repositories: Experian, Equifax and Trans Union. These are basically huge databases that house credit information on almost everybody in the country. And how do they get all this information about us? Well, creditors (like credit card, automobile and mortgage companies) are always looking for information about potential clients; people like you and me. They get that information from these repositories but in exchange, they agree to provide data about all their customers back into the same databases. Almost all of your credit providers report your payment history into these databases and every time you obtain a new credit account, that account is reported under your Social Security Number.
Credit reporting in its current form is still relatively new and a lot of people, particularly in the older generations, are still unaware of all this information being held about them and their credit histories. My own parents, for example, were shocked when I told them such databases exist and the extent of information available. And it’s amazing the number of things in our lives that are affected by our credit scores, so an understanding of the things they look for when calculating our scores can be incredibly beneficial for those who want to optimize their scores.
Let’s start with a definition. What is a credit score actually trying to reflect? Well, the exact thing a credit score intends to predict is the probability you’ll have a 90-day late on a trade account within the next 24 months. That’s what they’re actually trying to predict. And as you can imagine, there are a number of things that increase the probability you’ll have such a late payment and those are the variables that make up your credit score. Now, the formulas and algorithms being used these days are incredibly complicated and they change periodically as well, so it’s impossible to lay out the exact components and their respective weights. But the basic structure is well documented and that’s what we’ll focus on here.
First, you should know that the median credit score in this country is right around 720. That means half the population has a higher credit score and other half has a lower score. It’s actually just a bit higher than 720 – about 722 is the latest I’ve heard. Pretty high, huh? It’s true. So the average person in this country has pretty darn good credit. In fact, only about 1% of the population has a score below 500. That means at least half the population should be in A-paper mortgage programs. It’s true that income and assets also play a major role in mortgage underwriting but at least from a credit perspective, most people should be in A-paper mortgage programs. Sadly, that’s not the case.