11 Mar Understanding Algorithms and Credit Scoring Systems
Have you ever wondered how credit bureaus like Transunion and Experion calculate your credit score? At the heart of every credit score is a mathematical model, usually an algorithm, that calculates your score using the information on your credit report. The score is designed to assess your likelihood of repaying your debt, which helps creditors decide whether they should lend you money. Read on to understand how algorithms calculate your credit score and what is considered.
What’s an algorithm?
Algorithms are just a set of instructions computers use to complete a task. Like a recipe for computers to follow to break complex problems into step-by-step instructions. They use data as the ingredients (think payment history, defaults, etc) and the step-by-step instructions, the algorithm, to get to a result– your credit score. You see algorithms every day, whether you’re scrolling through Facebook or using UberEats.
How credit scoring algorithms work
So we know that an algorithm is just a set of instructions computers use to work complex problems. But how do credit scoring algorithms work? Well, just like any other recipe, it needs ingredients, including:
Payment history
This is probably the highest-weighted factor, taking into account whether you’ve paid your debts on time and how often.
Credit utilisation ratio
Credit utilisation is how much of your credit you’re using to how much you have available in total. Lower scores are better.
Length of credit history
A longer history of good payment is better than a shorter history of bad payment.
Types of credit accounts
A diverse credit portfolio–loans, credit cards, and other lines of credit–up your score.
Recent credit inquiries
Too many inquiries in a short amount of time, particularly hard inquiries, suggest you’re financially overextended.
Every factor is weighted differently, with payment history being the highest weighted. Based on the values of the different weighted factors, the algorithms work out a credit score, typically ranging from 300-850.
We hope you feel empowered in understanding how credit scoring algorithms work so you can manage and understand your creditworthiness. When you practice responsible lending habits, like paying on time, you can build a strong credit score and get better loan terms, lower interest rates, and open more doors to better financial opportunities.
Get in touch with us today for help clearing your credit score.