What is a credit score?
FREE
DOWNLOAD - Credit Scoring 101
Before deciding on what terms they will offer you a loan
(which they base on their "risk"), lenders want to know
two things about you: your ability to pay back the loan,
and your willingness to pay back the loan. For the
first, they look at your income-to-debt obligation
ratio. For your willingness to pay back the loan, they
consult your credit score.
The most widely used credit scores are FICO scores,
which were developed by Fair Isaac & Company, Inc. (and
they're named after their inventor!). Your FICO score is
between 350 (high risk) and 850 (low risk).
Credit scores only consider the information contained in
your credit profile. They do not consider your income,
savings, down payment amount, or demographic factors
like gender, race, nationality or marital status. In
fact, the fact they don't consider demographic factors
is why they were invented in the first place.
"Profiling" was as dirty a word when FICO scores were
invented as it is now. Credit scoring was developed as a
way to consider only what was relevant to somebody's
willingness to repay a loan.
Past delinquencies, derogatory payment behavior, current
debt level, length of credit history, types of credit
and number of inquiries are all considered in credit
scores. Your score considers both positive and negative
information in your credit report. Late payments will
lower your score, but establishing or reestablishing a
good track record of making payments on time will raise
your score.
Different portions of your credit history are given
different weights. Thirty-five percent of your FICO
score is based on your specific payment history. Thirty
percent is your current level of indebtedness. Fifteen
percent each is the time your open credit has been in
use (ten year old accounts are good, six month old ones
aren't as good) and types of credit available to you
(installment loans such as student loans, car loans,
etc. versus revolving and debit accounts like credit
cards). Finally, five percent is pursuit of new credit
-- credit scores requested.
Your credit report must contain at least one account
which has been open for six months or more, and at least
one account that has been updated in the past six months
for you to get a credit score. This ensures that there
is enough information in your report to generate an
accurate score. If you do not meet the minimum criteria
for getting a score, you may need to establish a credit
history prior to applying for a mortgage.
How can you improve your credit
score?
It's virtually impossible to change your score in the
time between when most people decide to buy a home or
refinance their mortgage and when they apply. So the
short answer is, you really can't "on the spot." But
there are strategies you can live with to make sure when
you apply for a loan your score is as high as possible.
Make sure that the information each of the three credit
reporting bureaus has on you is consistent and up to
date. Order a copy of your credit report about once a
year, and dispute any inaccuracies.
Note: Theoretically, if a series of credit reports is
requested on your behalf during a limited amount of
time, your score goes down until time passes without any
inquiries. Changes in the law though have made
"consumer-originating" credit report requests not count
so much. Also, a series of requests in relation to
getting a mortgage or car loan is not treated the same
as a number of credit card requests in a limited time.
This is because the credit bureaus, and lenders, realize
that people request their own credit reports to keep up
with what's on them, and smart consumers shop around for
the best mortgage and car loans.
Unsolicited credit card solicitations in the mail don't
count against your credit report, so don't worry.
The two main components of your credit score are your
payment history and the amounts you owe. Bankruptcy
filings and foreclosures, which can stay on your credit
report for as many as 10 years, can significantly lower
your score. It's never a good idea to take on more
credit than you can handle.
Late payments work against you. It's extremely important
to pay bills on time, even if it's only the monthly
payment.
Dont "max out" your credit lines. Since the size of the
balance on your open accounts is a factor, lower
balances are better.
It's said that by carefully managing your credit, it's
possible to add as much as 50 points per year to your
score.
