We all know that credit is important when we want to purchase large items that we can’t afford upfront, such as homes and vehicles.
But do you know how your credit is actually measured? Do you understand the factors that are considered to create a score of 440, 550, or 720?
While credit can be complex, we’ll do our best to explain the complexities of the credits scores. And as you’ll learn, they’re really not complicated at all…
Credit 101: Understand Your Credit Score
The Major Credit Bureaus: Creating Credit Reports
A person’s credit profile starts with the three major credit bureaus: Equifax, Experian, and TransUnion. These bureaus are not government agencies, but rather publicly-traded companies. While they are private companies that operate for profit, the government has passed laws, including the Fair Credit Reporting Act, that addresses how these agencies operate.
Credit bureaus essentially act as reporters of credit-based activity; they receive credit information from the various companies with which you do business. For example, if you have a credit card, car loan, and store card, these companies will send your debt and payment information to the bureaus. The companies will not report all information to all the bureaus, but the groups generally do a good job of establishing a reliable credit profile. The bureaus will also access related public information, such as tax liens and bankruptcies.
The bureaus then sell this information to businesses who have a legally-valid reason to access this information. For example, an auto lender would need this information to see that you are creditworthy, and may make decisions based on this information.
Each credit bureau uses a different system for creating your credit profile. This means that your credit report may be different depending on which one you’re accessing. Using your credit reports, you will then be assessed a credit score.
FICO: The Source of Your Credit Score
Using your credit reports, which is essentially a listing of your credit activity, the Fair Isaac Corporation, or FICO, creates your credit scores. These numbered scores are essentially the result of mathematical equations that attempt to assess your credit worthiness in a simple, clear manner: the higher the score, the more creditworthy you are.
You will have three FICO scores, one for each bureau. Each one is based on the information pulled from the specific bureau, so they can differ slightly. However, it is unlikely that you would have scores that are vastly different.
How a FICO Score is Measured?
FICO uses a wide variety of information from the credit bureaus to create your score. However, not all information is given the same level of importance…
Payment History: 35%
For obvious reasons, your past payments are given the most importance when measuring your credit score. Lenders want to know that you are reliable and organized, so the FICO score starts by looking at your payment history, which includes payments on credit and retail accounts, car loans, mortgage loans, and more. This portion of the credit score will also include bankruptcies, foreclosures, liens, and other public information.
Amounts Owed: 30%
The next most important factor on your credit score is the total amount you owe. Owing money doesn’t automatically mean you will have a low score, but keeping the total amount within reason will go a long way towards your overall creditworthiness. This section factors the amount on all accounts, the amount owed on credit cards vs. installment loans, and the percentage of available credit you are using. It also considers how many accounts you have, as a large number of open accounts can create a credit risk.
Length of Credit History: 15%
After payment history and credit amount, the importance level take a sharp decline, but that doesn’t mean that these areas are unimportant and can be ignored. Length of credit history makes up 15% of the overall score, and it examines how long you have been using credit. The longer you have been borrowing money, the better your score will be, as it’s reasonably assumed that people who have used credit longer are less of a credit risk. This section takes into account how long accounts have been open and how long it has been since you used certain accounts.
New Credit: 10%
It’s been established that people who open multiple lines of credit in a short period are a greater risk for default on loans. These lines of credit, such as credit cards, auto loans, and HELOCs, can be troublesome when taken all at once. This is especially true for people who have minimal credit history. The bottom line here is to simply avoid opening a lot of accounts rapidly.
Credit Mix: 10%
Although credit mix will rarely be a key factor in determining your creditworthiness, it can make a difference in your score. Having a good mix of credit, including installment loans, credit cards, and mortgage loans is a good idea if raising your score is the goal. However, it’s not recommended that you open lines of credit that you don’t intend to use.
What Information is Not in Your Score?
While a lot of information can be found in your credit score, it’s important to note that there are many items that will never be included in factoring your overall score. Most notably, your salary and overall income is not factored into your score. Lenders will often want this information, but for the sake of your FICO score, it is not included; nor is your occupation, employment status, or employer.
Interest rates being charged to your account are also not considered, and child or family-support obligations will not be included.
The FICO score will also not include any personal or demographical information, such as race, sex, religion, marital status, or national origin. This information is off limits to credit bureaus and organizations because of laws passed through the Consumer Credit Protection Act of 1968.
Although FICO may consider the amount of time you have had credit, they will not take into account your age.
Complete Support, No Matter What Your Credit Score
No matter what your credit score, we take a common-sense approach to mortgage loan underwriting.
While we can’t guarantee final approval, our expert team understands how to increase your chances, even if you have a low credit score. This could help you get the comfortable, affordable home you deserve, so contact us today!
I was referred to Chad by my Realtor for a purchase of a new house. The experience with Chad and the team (I mainly worked with Juliann) was nothing short of outstanding. From start to finish there were always quick to respond and when needed, notify me of any new documentation that was required. There were very helpful explaining to me the pros and cons of different financing options as well as some other loan related issues, such as termite clearance outside the purchase contact and septic tank certification process. Overall, very knowledgeable and processional team. Loan preapproval was done in a single day and loan documents were ready for signing in 21 days, which was 9 days ahead of schedule. That never happened to me before.
I was amazed how quickly Chad was able to knocked out our refinance!. I highly recommend Chad he & his team did an incredible job! I had 3 others I was working with, including a Credit Union. Chad was able to offer me a lower rate with no fees! Based on the other 3 top financial bids I had for this refinance. ”
“Chad and his entire team were over the top amazing, professional, and attentive throughout the entire home loan/buying process. I could not have asked for a better team to have on my side through what could be one of the most challenging and stressful processes one experiences. From the first conversation I had with Chad, I felt comfortable with him. He helped guide us through the process without ever once making us feel uneasy, unimportant, or uninformed. I never felt silly or stupid for asking the same questions over and over until I fully understood what we were getting into, or until something made total sense to me. The home loan world is fast paced, overwhelming, and confusing, and Chad and his team held our hands and helped us to feel comfortable and confident about our choices. He and his team were always there for us day or evenings, weekdays, or weekend and never made you feel like you were a bother if you had a burning question you had to get answered at 8pm Saturday night. I will use them again and again, and suggest them to any friend, family, or acquaintance. Seriously, they are rock stars. They work hard for you to get you into your dream home, we could not be happier with their hard work, dedication, and kindness.”