Credit Basics

By now you might have heard that the three major credit bureaus have introduced a new scoring system they hope will someday replace the current FICO credit score.

Equifax, Experian and TransUnion recently unveiled what they are calling VantageScore, a system that will reportedly simplify credit-risk scoring that helps determine what interest rate consumers will pay.

Eventually, the companies would like credit grantors - banks, credit card companies, auto dealers, mortgage lenders - to stop using FICO scores, which are calculated using software developed by Fair Isaac Corp.

FICO is the most widely used scoring model.

The three bureaus hold the financial histories of millions of people.

The information in the files is used to create a score from a low of 300 to a high of 850 in the case of the FICO system.

The credit bureaus say they've introduced this new system so that the scores being reported to credit grantors are consistent and easier to interpret. To understand what that means, you need to know that while we all get a score generated from each bureau, how those scores are determined can vary greatly.

That's because each bureau uses a different formula to generate the score it sells to lenders.

So let's say you're applying for a mortgage. The lender pulls all three of your credit scores from the three major credit bureaus. You have a 750 from one bureau, 700 from another, and 675 from the third.

To reconcile the different scores, a mortgage lender will typically use the middle score of 700 to decide what kind of interest rate it will give you (other factors are also used, of course).

I recently conducted a workshop on credit. I asked the participants to pull their credit scores beforehand. One woman had a score in the low 800s from one bureau and a score in the 500 range from another.

Let's say this woman was shopping for a car and the dealer only pulled her score from the bureau that had assigned her the 500 score. That difference could cost her thousands of dollars over the life of her car loan if she took the financing the dealer was offering.

If another lender used the bureau that generated the score of 800, she would qualify for a better interest rate.

The VantageScore system uses a scale that ranges from a low of 501 to a high of 990. TransUnion said the bureaus' version of three-digit score approximates the letter-grade system we're all familiar with from school.

So a score of 901 to 990 would be the equivalent of an A, 801-900 a B, 701 to 800 a C, 601 to 700 a D and 501-600 would be an F.

With VantageScore, all three credit bureaus would still generate scoring using information from a consumer's credit file. But the formula used to determine a score would be the same, thus eliminating part of the reason scores can vary so much, according to the agencies.

"We wanted to take away a certain degree of variability," said David Rubinger, a spokesman for Equifax.

That claim sounds reasonable except there's just one huge problem. The scores under the new system could still cause a Grand Canyon-like spread.