The History of Credit Scores
Over the years, credit scoring has matured into a required tool mortgage lenders use to quickly evaluate a credit application. Yet credit scoring isn’t necessarily a new invention.
Even before the three digit number became a staple in the mortgage industry, and way before the advent of the internet, lenders employed underwriters who would manually review, line item by line item, each and every credit account to look for derogatory information. When a late payment was found and could not be explained away, the underwriter would count that negative against the borrowers until the count became too high and the credit could not be approved.
Today, the regularly updated algorithm used by mortgage companies was originally developed by the Fair, Isaac Corporation which later changed its name to FICO. FICO scores are three digit numbers that can range from as low as 300 and as high as 850. These scores are calculated using weighted data. Some information in the credit report is more important than others.
When lenders receive a loan application and request a credit report, they make an additional request from the credit bureaus to provide a credit score. These requests are made at TransUnion, Equifax and Experian and all three use the very same FICO algorithm yet most often these scores are different from one another. Not by much, but different nonetheless.
For example, three credit scores are returned and they read “721, 730 and 734.” Due to variances in reporting times and how long some information has been in one database compared to another will result in slight variances of a score. Credit reporting rules mandate that if one bureau receives information about a credit file, the information is to be shared with the remaining two bureaus. However, this isn’t always the case and it can take 30 days or more before new information shows up in one database and another 30 to appear in the others.
Lenders order three scores to get a better picture regarding credit patterns. When getting these scores, the lender tosses out the highest and the lowest and uses the middle score. Lenders do not average the scores together. Okay, now that we have a little background, let’s dig a bit deeper and find out what metrics these scores use and how you can take advantage of them when improving your credit scores, no matter what type of credit you now have.
The Five Categories That Affect Your Credit Score
We just mentioned there are different metrics used in the algorithm.
Here they are:
Payment History. This category carries the most weight when FICO scores are calculated. When a payment is made more than 30 days past the due date, credit scores will fall. When a payment is made more than 60 days past the due date, scores fall further still. And more than 90? You guessed it, they keep dropping.
If an account goes into collection, scores continue to free fall and if an account goes to court and a judgement is issued, we’re getting closer to the bottom here. Payment history accounts for more than one-third of the total score.
Account Balances. Account balances compares the outstanding amount due with the total credit line. This involves revolving accounts and looks at how much credit is being used and not paid back. When someone charges say $4,500 on a $5,000 credit card yet only makes the minimum payments, the available credit to the consumer begins to vanish. When account balances begin to approach the credit limit, scores fall. If the balance goes over the credit limit, it’s almost a free fall. This category accounts for 30% of the credit score.
Length of Credit History. Simply put, the longer someone has had a credit history the better the credit score will be and accounts for 15% of the total score.
Types of Credit. Various types of credit used, responsibly, will help a credit score. Credit taken from so-called lenders such as finance companies can initially harm a score yet with timely payments, scores can improve.
Inquiries. When consumers check their own credit online there is no “hit” to a credit score. However, when consumers apply for credit with several lenders at once, it can indicate there are potential future credit problems ahead. A credit inquiry is a direct request from a consumer and not as a result of a creditor sending you a credit card offer. Types of credit and credit inquiries each comprise 10% of the total score.
Getting Better : Improving Your Credit Score
Okay, so now we know the categories. Let’s take that knowledge and apply it to getting scores higher. If you concentrate on both the payment history and account balances you’ll have affected nearly two-thirds of the score. That suggests concentrating on those two at the outset.
1: Keep your payments on time. If your monthly payment is a few days past the due date, the scoring algorithm won’t take notice, although your lender could apply a late fee.
2: At the same time, if you keep your credit balances around one-third of your credit lines while at the same time making timely payments, your scores will also improve.
3: There’s not a whole lot you can do regarding how long you’ve had credit but the combination of time and items #1 and #2 will keep your scores rising.
4: Don’t close revolving accounts. While it might seem a bit counterintuitive to not pay off a credit card and close the account, scores actually improve when you carry a small balance.
5: The best action you can take is with a mortgage. Making timely payments on a home loan carries the single greatest weight with a credit score. If you have to let a payment go past the 30 day line and you’re kind of strapped, just make sure the home loan is paid first.
It may sound a bit too simple but seriously, by paying attention to these five methods, your scores will begin to improve within 60 days.
