Know the Score: Credit Score Modeling and Impacts

The lesson includes five activities that instructors can select from. In these activities, students will:

View and debrief the YouTube video Understanding How a FICO Credit Score is Determined

Use the Class Grading Activity with an Excel® template containing weights for a class grade to
simulate how credit scores weight key factors related to creditworthiness

Conduct a Web Quest by searching online for “how to increase your credit score”

Complete an activity to calculate the cost of credit (interest) for borrowers with different credit scores

Take an online or print Credit Score Quiz to assess credit score knowledge (as a pre-and/or post-test)

The lesson also contains 10 assessment questions (5 multiple choice and 5 True-False), learning extensions

(i.e., suggested learning activities beyond the scope of the lesson plan), and references and resources

INTRODUCTION (Background for the Instructor)
Credit reports are like a “report card” in school. Credit scores are similar to a grade point average (GPA).

They are a three-digit number, ranging from 300 (lowest) to 850 (highest), used to measure the risk that borrowers will become delinquent or default on debt obligations. Credit scores are based upon the information contained within credit reports. Thus, consumers will likely have different credit scores from each of the three major credit bureaus (Equifax, Experian, and TransUnion), just like they have different credit reports. This is because information on which credit reports and scores are based may vary among credit bureaus.

Some creditors may elect to provide information to only one or two credit bureaus instead of all three. Credit scores are not required by law to be provided to consumers annually free of charge, upon request, the way that free credit reports are. However, an increasing number of creditors are now providing credit scores free of charge anyway, as a way to attract and retain customers. Otherwise, consumers generally must pay a fee to get their credit score. There are also some Web sites that provide free credit reports (e.g., Credit Karma, Credit Sesame, Quizzle). These sites provide a rough estimate of credit status but are not the FICO score that most lenders see. Average FICO credit scores fall between 670 and 680 (median of 710).

Credit scores are determined by statistical “risk models” based on algorithms (i.e., rules followed by
computers to make a calculation) and are often referred to as FICO scores. FICO is an abbreviation for Fair, Isaac, and Company, a company that develops the credit scoring models used by a large majority of U.S. banks and mortgage lenders. Negative events, such as late payments or charged-off debts, will cause credit scores to drop. Conversely, a sustained record of on-time debt payment will raise a credit score.

The higher the credit score number, the better, because it helps borrowers qualify for credit and obtain the most favorable terms. Conversely, “subprime” borrowers with low credit scores pay higher interest rates to borrow money, if they are approved at all. The exact threshold for the best credit terms varies among lenders but is generally somewhere in the low- to mid-700s (e.g., 720 to 760). A high credit score can save thousands of dollars in interest payments, particularly on long-term loans such as a home equity loan or mortgage.

OBJECTIVES
Students will be able to:

Describe what a credit score is and how it is used by potential lenders and others (e.g., auto insurance).

Identify the five key components of a credit score and ways to improve a credit score.
Understand how a weighted average is used to calculate a credit score.

Calculate and compare the cost of credit for borrowers with different levels of credit scores.