With the unemployment rate at 9.5%, people are worried whether their credit score will be negatively affected by losing a job or collecting unemployment benefits.

Luckily for consumers, the answer is “no” because income or loss of a job are not factors in compiling a VantageScore credit score and most other generic credit scoring models do not include income in their calculations.

Some of the confusion over this may stem from new federal legislation, known as the “CARD Act,” which requires lenders to further verify a prospective borrower’s ability to repay the debt before approving a loan or credit-card application.  Because of this requirement, which took effect Feb. 22, 2010, many people accustomed to applying for “instant credit,” which often relied on a credit score as the single determining factor, may find themselves sharing more information than in the past.  

 

A credit score is a number derived through statistical means that predicts the likelihood of whether or not a consumer will have serious delinquencies (90 days late or greater) on a credit account in the future.  

 

A credit score is generated from data on a credit report – a variety of credit history-related elements, such as a person’s history of payment punctuality, the total amount of available credit, the total amount and type of debt, the number of open and active accounts and the longevity of relationships with creditors.

 

It is important to note, however, that because the major consumer characteristic contributing to a VantageScore credit score is “payment history” (approximately 32%), consumers should make every effort to make payments on outstanding debts to avoid any negative impact to a credit score.

 

While losing a job or filing for unemployment benefits doesn’t impact a credit score, missing a payment certainly does.

Also included in a credit score are other characteristics including:  “utilization” (23%) - the percentage of credit amount used or owed on accounts; “balances” (15%) – the amount of recently reported balance, both current and delinquent; “depth of credit” (13%) – the length of credit history and types of credit; and “recent credit” (10%) – the number of recently opened accounts and credit inquiries; and “available credit” (7%).

 

When making loan decisions, lenders rate your creditworthiness, which includes both your ability to repay a loan and your willingness to repay a loan, among other considerations.  Income provides a good indicator of your ability to repay the obligation, but it doesn’t mean you will.  Credit scores help lenders understand your willingness to repay the loan.

 

Because a credit score is calculated from borrowers’ history of paying other loans, it provides lenders with an objective measurement of their likelihood to repay loans in the future. Even someone with high income can have a poor credit score if they don’t repay their obligations on time.  The reverse is also true – a lower-income individual may have a high credit score because they have demonstrated responsible repayment behavior.

Here’s what typically happens as lenders evaluate credit applications:  Credit scores will be reviewed early in the process to assess the applicant’s likelihood to default. If the score is below the lender’s minimum standard, the application could be rejected at this stage. No lender wants to approve a loan to someone who hasn’t demonstrated a willingness to repay other loans in the past, even if they have the ability to do so now.  If the credit score is above the minimum threshold, then other credit criteria for that applicant are evaluated against each lender’s own standards.  This part of the process is known as “underwriting.”

At many banks and other major financial institutions, income is considered one of the most important components of the loan application process, but it’s not part of a credit score.  Credit scores contribute to lending decisions, but it isn’t a substitute for a thorough credit analysis and prudent “underwriting” of a potential borrower.

It’s important for consumers to understand their credit score and the role it plays in the lending process, but statistics show many don’t. Recently, a survey from the Financial Industry Regulatory Authority (FINRA) Investor Education Foundation showed only 36% of consumer respondents had checked their credit score in the past 12 months, although 38% had checked their credit report.   

Knowledgeable consumers who borrow prudently are vital to our economic recovery because credit represents opportunity, whether in home or auto ownership, financing a new business or funding a college education.

Banks, credit card companies and other lenders will use credit scores to assess a borrower’s loan eligibility and set loan/credit terms, but in this new regulatory environment, consumers should know they will be judged on more than just a three-digit number.

 

Barrett Burns is president and chief executive officer of VantageScore Solutions, a company launched by the nation’s three major credit reporting companies (CRCs) - Equifax, Experian and TransUnion to offer VantageScore, a generic credit scoring model.  He has more than three decades of professional experience in risk and credit management and has held a diverse number of national and international leadership positions with companies including U.S. Trust, Ford Motor Credit, Bank One and Citibank.