Credit Scoring

Presented byWill VanderToolen

Director of Counseling ServicesAAA Fair Credit Foundation

www.faircredit.org

1. Understand Credit Scoring and Credit Reports

2. Help students understand Credit through the use of classroom activities

What do we want to Accomplish:

A Little Credit HistoryCredit reporting was born more than 100 ago, when small retail merchants banded together to trade financial information about their customers. The merchant associations then turned into small credit bureaus, which later consolidated into larger ones with the advent of computerization.

By the 1960s, CRAs back then reported only negative financial information as well as "lifestyle" information culled from newspapers and other sources -- information such as sexual orientation, drinking habits, and cleanliness.

The controversy led to a congressional inquiry, and in 1971, Congress passed the Fair Credit Reporting Act (FCRA), which established a framework for fair information practices to protect privacy and promote accuracy in credit reporting. Consumers gained the right to view, dispute and correct their records, and CRAs began to supplement the often-bleak reports with information on consumers' positive financial history.

What is a Credit Score?• Snapshot of a person's financial standing at a

particular point in time• The one most widely used is the "FICO" (Fair Isaac

Corporation) score• The FICO score, a three-digit number between 300

and 850• The scoring system awards points for each factor

that can help predict the likelihood of a person repaying debts on time

• The higher a credit score, the more likely a person is to be approved for loans and receive favorable interest rates.

National Averages

National Distribution of FICO Scores

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30%

FICO Score Range

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How Are Credit Scores Calculated?

• Scores are computed using a patented mathematical algorithm, designed and sold to credit bureaus by FICO. (VantageScore™ recently released)

• There are theories as to what affects or does not affect your score but no one, especially FICO, will give you the formula, so in reality it is any ones best guess.

• Your score considers both positive and negative information in your credit report.

Other Names for Credit Scores

FICO scores have different names at each of the credit reporting agencies. All of these scores,

however, are developed using the same methods by Fair Isaac, and have been rigorously tested to ensure they provide the most accurate picture of

credit risk possible using credit report data.

CRA Credit ScoreEquifax Beacon

Experian Experian

Trans Union Empirica

Credit Scoring Methodology VantageScore

FICO and VantageScore use two different ranges. The classic FICO scale runs from 300 to 850, while the VantageScore starts at 501 and runs to 990. The credit bureaus are now saying the VantageScore range is more "intuitive," because it breaks down like the familiar academic scale:

901-990 equals "A" credit801-900 equals "B" credit701-800 equals "C" credit601-700 equals "D" credit501-600 equals "F" credit

Fair and Accurate Credit Transactions Act (FACTA)

• www.annualcreditreport.com (ACR) enables consumers to request a free credit report once every 12 months from Equifax, Experian, and Trans Union

• ACR is the only source authorized by all three nationwide credit reporting repositories

• ACR provides consumers with a safe, secure, convenient way to request credit reports annually

Obtaining a Copy of Your Credit Report

• Internet • www.annualcreditreport.com

• Mail• Annual Credit Report Request Service

P.O. Box 105281Atlanta, GA 30348-5281

• Phone• 1-877-322-8228

How do I obtain my Score?

• You can purchase your credit score from each bureau– www.equifax.com– www.experian.com– www.transunion.com

• You can also purchase it at www.annualcreditreport.com

• All three scores may be different (due to reports containing different information)

How Does A Credit Score Help Me?

• Improves risk assessment– Lenders, Insurance, Employers, Housing

• More equitable treatment among borrowers

• Able to qualify more quickly for credit

• Credit “mistakes” will not affect your ability to obtain lending as drastically

What’s In Your FICO Score?

Payment History

• Pay your bills on time.

• If you have missed payments, get current and stay current.

• Be aware that paying off a collection account will not remove it from your credit report.

Amounts Owed

• Keep balances low on credit cards and other “revolving credit”.

• Pay off debt rather than moving it around.

• Negotiate with creditors for better terms.

Length of Credit History

• Rapid account buildup can look risky if you are a new credit user.

• Don't open a number of new credit cards that you don't need, just to increase your available credit.

• Don't close unused credit cards as a short-term strategy to raise your score.

Types of Credit Used

• Apply for and open new credit accounts only as needed.

• Don’t use unnecessary credit just to try and build your score.

• Use and manage credit cards responsibly.In general, having credit cards and installment loans (and paying timely payments) will raise your score.

• Note that closing an account doesn't make it go away. A closed account will still show up on your credit report, and may be considered by the score.

Credit Maintenance Overview

• Don’t get into debt just to build credit.• Avoid becoming overextended. This

will lower your score.• Avoid excessive accounts. Having too

much available credit can create concern with lenders.

• There is no quick fix if your credit has been damaged. It will take time and planning.

Plan your Credit Makeover

• Obtain your credit reports

• Review and understand your credit

• Dispute any discrepancies

• Review the types of credit you have

• Make all payments on time

• Pay down debt

• Maintain accounts long-term

Application for Students

What I Knew in HS

• I needed to save before purchasing

• It is important to pay bills on time

• I should work hard for my paycheck

What I Didn’t Know

• How interest works

• Balancing Accounts

• In depth understanding of credit

• Credit Reports

• Budgeting

• How investments/stocks work

National Endowment for Financial Education (NEFE)

• 19% almost always confident with financial decisions

• 18.5% set aside money as savings

• 42% say they knew the difference between needs and wants

• 9% set financial goals

Credit Score

• Homework for a class = Payment on an account

• Good Grade = Positive Account This leads to:

High GPA = High Credit Score This leads to:

Qualify for College = Qualify for Loan

Pop Quiz

• Needing credit can be like a pop quiz• You don’t always know when it will

happen…(need new auto after accident)

• Think about what your grades look like right now, how are you doing?

• The same is applicable to credit

Credit Worthiness

• Which friends are you likely/not likely to lend money to? Why?

• What would you say if another person asked you if it were safe to lend to your friend?

• What if someone you didn’t know wanted to borrow from you?

Credit Score Estimator

• MyFico.com (credit score estimate)

• Create multiple scenarios– Name, # of Accts, Payment History, etc.

• Have kids research scenarios

• Class - guess the estimated score

• Preferential treatment to high scores

Why work for a High Score?

• Lower Credit means the bank considers you a higher risk, they require a higher return (Interest Rate)

• You have a higher rate, which means a higher payment for the same item.

• Different credit types offer different rates

The Cost of Credit - TV

• Television: Regularly $900, on Sale for $850

– Savings- the cost is $850 ($900 if no longer on sale)

– Credit Card – at 21% interest over 12 months the cost is $79 per month or $950

– Rent to Own – at 100% interest over 12 months the cost is $114 per month or $1377

Cost of Credit - Auto

• An Automobile Loan – Pay $15000– Loan Terms 60 months at 7%– Payment = $297 a month– Total Cost of payments

= ($297)x(60 months) = $17,821

Cost of Credit - Auto

• New Situation – Poor Credit History

• An Automobile Loan – Pay $15000– Loan Terms 60 months at 17%– Payment = $372 a month– Total Cost of payments

= ($372)x(60 months) = $22,367

Cost of Credit - Mortgage

• Mortgage Financing – Pay $200,000– Loan Terms 360 months at 6%– Payment = $1199.10 a month– Total Cost of payments

= ($1199.10)x(360 months) = $419,796

• Bad Credit– Same loan at 8%, Payment = $1467.53

Cost = $528,310

Before you Buy

Ask yourself these three questions:1. Is this item worth going into debt

for?2. What makes you think you will have

the $ to pay it next month if you don’t have the $ this month?

3. How much will the item cost with interest included if you re-pay over time?

Credit = Savings Account

• Country is at a point where the Savings Rate has been negative

• We spend more than we make

• We transform wants to needs

• Credit has become the savings account

• How is this different from times after the depression?

Self Evaluation

• Is the Student responsible for any payments (How often are they paid on time/late?)

• Do they know the difference between Debit / Credit cards?

• Do they know how interest works (use amortization schedules)

• Know how to create/follow a budget

• Do they balance bank accounts?

Self Evaluation (cont.)

• How well do they manage cell phone plans?– Do they go over their minutes/texts?

• This could be an indicator of how they would use credit– NOTE: If they have unlimited texts, know that

there isn’t unlimited credit

– Could they restrict themselves, Try

Rate Shopping

• Have students shop around for the best rates on bank accounts– Don’t forget to get the fine print

• Visit Credit Card sites in class, view the application and read the fine print

• They always shop for the best product, they should also shop for credit

Budgeting

• Help them develop a ledger– One for each account– Having checks doesn’t mean you have $

• Track ALL income and expenses– This can be done on paper, computer, check

book, etc.– Track debt payments (possibly to parents)

• Compare to Business cash flow

Avoid the Credit Traps

• High Interest Predatory Loans

• Free T-shirt / Blanket / Hat• Buy now pay later (with huge interest cost)

• Music or other clubs with required purchases

• Co-signing

• Read the fine Print

Budget Homework

• Research the cost of living– Average Family Costs: Housing & Utilities,

Transportation, Food, Clothing, Medical, Etc. – Call and get quotes, speak to others about costs

• Develop a Budget– How much income is necessary?– What if credit is bad, payments increase?– Evaluate ways that families can save money

Payment Organization Homework

• Create a list of bills– Due dates, Minimum payments, Balance

• Organize the bills so that they are paid on time and according to income– Show savings from previous month may be necessary

due to the timing of due dates and pay dates

Class Investment

• Have each class member pick a stock

• Create a pretend portfolio with a certain amount of $ invested in each stock

• At semester’s end, see how each stock and the portfolio have changed

Who wants to be a Millionaire?

• The time value of Money at age 18:– Save $91 a month until 65– ($91)*(47 Yrs)*(12 Mo/Yr) = $51,324– At 10% Investment Return, you will make $1 million

from 51K!

• Wait until 40 to start saving:– You will need to save $805 per month– ($805)*(25 Yrs)*(12 Mo/Yr) = $241,500– You will still make $1 Million, but it will cost more

Resources

• www.utjumpstart.org• www.fdic.gov (Money Smart Curriculum)

• www.myfico.com • www.handsonbanking.com • www.nafcu.org (Financial Education Curriculum)

• www.consumercents.com (Financial Literacy)

• News Sites• Bank and C.U. Sites

Questions & Answers

Will VanderToolenAAA Fair Credit FoundationDirector of Counseling & Education

800-351-4195will@faircredit.orgwww.faircredit.org