Did You Know about the numbers behind the numbers?

Date: June 25, 2020

You can’t turn on the television or fire up a browser without hearing or reading about someone willing to give you a free credit score. That’s the good news. The bad news is that there’s not much explanation of what that score actually means.

Most people get their score and walk away knowing nothing other than the number. But what does that number actually mean to a lender, landlord, insurance company or other service provider that depends on credit scores as part of their decision making process? The answer lies in your score’s relationship to probability of default (PD), or the likelihood you’ll make your payments on time.

Lenders use credit scores to group you and other consumers according to PD, expressed in terms of a probability, like the odds of one football team beating another.

For example, for a credit score range of 750-759, a credit card issuer may anticipate one cardholder default out of every 100 of their cardholders. For that card issuer, the odds of defaulting for the score range of 750 to 759 might be 100 to one. Or, more simply, the card issuer might have only one cardholder go into default for every 100 cardholders that do not. Those are pretty good odds for the card issuer, and that’s why consumers who have solid credit scores in that range typically get such good deals from lenders.

As scores get lower and lower, odds of defaulting increase, reflecting greater risk among borrowers. As an example, for a score range of 620-629, a card issuer might have only 25 good customers for every one that defaults. Because the lender is taking on more risk at the lower credit score range, it’s likely to subsidize that risk by charging borrowers with lower scores higher interest rates.

There are a few things to keep in mind as it pertains to odds by score range. First, credit scoring models are designed to assign higher scores to lower-risk consumers and lower scores to higher-risk consumers. That means people with higher scores, as a group, default at a lower rate than groups of consumers with lower scores.

Second, the odds experienced by one lender aren’t necessarily going to be the same as those experienced by another. So, Lender A may see odds of default at a score range of 750-759 as 100 goods to every one bad. Lender B may see odds of default of 150 goods to every one bad at the same score range. That’s why it’s important that lenders perform analyses to better understand how their customers are going to perform across different score ranges. It’s not uniform.

As a consumer, you cannot control the odds of default at any given score range. But, you can rest assured that those of you with higher scores are always going to be considered a better credit risk than those with lower scores. So the next time you get your credit score, keep in mind that your “800” has a much deeper meaning than just the number itself.