It’s likely that even before you started thinking about buying a home, you’d seen or heard the term “credit score.” It seems simple enough. It’s just a three-digit number, right? Well, yes and no. While the score itself is designed to provide a quick measurement of your creditworthiness at a glance, how it’s used and calculated is a bit more complex.
How the credit score was born
The credit score as we know it was introduced in 1989 by software company FICO. So it can also be called the “FICO score.” In the United States, consumer reporting agencies Equifax, Experian, and TransUnion track these scores based on credit information they provide to FICO. Individual scores generated by FICO for each of these agencies can and often do vary based on access to different records. However, all of them fall within a range between 300 and 850, with 700 or higher being recognized by most lenders as an indicator of good financial health.
Wondering how your credit score affects your ability to buy a house? Find out how much home loan you prequalify for here.
According to MyFico.com, 90 percent of the largest U.S. financial institutions use FICO scores to make credit decisions.
Among the transactions for which they can be checked:
- Home loans
- Property rentals
- Job hiring
- Credit cards
- Mobile phone service
- Utilities and cable
For mortgage lending in particular, your FICO score is a major factor in deciding whether your loan is approved. And at what interest rate. Over the entire life of a mortgage, a variation of one to two percentage points can make thousands of dollars’ worth of difference in interest payments. With so much affected by your credit score, it’s important to understand not just how it’s figured, but what steps you can take to improve it.
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How is my credit score calculated? The 5 biggies
So, just how is your score determined? FICO calculates it based on five factors that are weighted using percentages:
1. Your payment history (35 percent of score)
The most important consideration is how consistently you’ve made payments on all of your previous and current credit accounts. Late payments lower your score, so be sure to always pay on time.
2. How much you owe (30 percent)
The next item that influences your credit score is how much you presently owe on all of your open accounts, how many balances you have, and the amount of available credit you’re using. The goal here is to lower the percentage of your total credit limit that you still owe, and typically you should aim for keeping card balances to less than 30 percent of their limit.
3. Length of credit history (15 percent)
The longer you’ve had active credit and made timely payments, the better your score will be. There’s not much you can do now to change how long you’ve had credit, but you can focus on being as responsible as possible with your current financial management.
4. New credit (10 percent)
Whenever you open a new line of credit, an inquiry is performed that negatively affects your score. The one and only exception is when you’re shopping for a home, as all mortgage inquiries within a 30 day period count as a single instance. To maximize your score, minimize other credit inquiries.
5. Other factors (10 percent)
Miscellaneous items can also have a minor influence on your score, like using a variety of credit types such as home and auto loans, cards, and personal lines of credit. It’s probably not a good idea to open a lot of new accounts just for this reason, because of the new credit penalty—but if you already have a diverse history, you’ll probably have a higher score than if you didn’t!
Knowledge is power. Check out our learning center to get well-acquainted with your mortgage.
What to do when you’re unhappy with your credit score
One of the first steps to improving your credit score is actually viewing your credit history. There’s no reason to not do so, since you have access to a free copy from all three reporting companies once a year at AnnualCreditReport.com.
You can also contact each of them individually:
Keep in mind that companies that charge for credit reports are not only requiring fees you don’t otherwise have to pay, but often don’t provide records that are as accurate as those of these three main agencies.
After receiving your reports, review them carefully. Specifically, check for any incorrect late payments or credit limits, or missing current accounts, so that your credit history and FICO score accurately reflect your financial activity. If you see any mistakes, notify the appropriate credit bureau within 30 days of the report date. There’s no cost associated with setting the record straight … It’s your right!
Whether you’re buying a house or car, looking for a job, or even just ordering cable, your credit score can either open or close doors. Knowing how it works, and that you’re ultimately in control, will help you to take full advantage of this simple yet significant number. Remember, your credit score impacts your mortgage interest rate. A lower interest rate may mean a more affordable mortgage. Contact one of our loan officers for help.
For educational purposes only. Please contact your qualified professional for specific guidance.
Sources are deemed reliable but not guaranteed.