Understanding Credit Scores
Your credit score is a numeric summary of the information in your credit report and is formulated to predict the risk you will not repay what you borrowed. The most commonly used scoring model is issued by the Fair Isaac Corporation. Called a FICO score, it ranges from 300 to 850, with a higher score being indicative of less risk. Generally, those with higher scores are more easily granted credit and get better interest rates. While there is no uniform standard for what constitutes a “good” credit score, one benchmark to keep in mind is that many mortgage lenders look for a score of at least 680 for approval and mid-700s for the best interest rate.
FICO scores only look at the information in credit reports that is predictive of future credit performance. Income, employment history, race, religion, national origin, gender, marital status, and age are not considered. The following are the factors used to calculate your FICO score:
- Payment history (35%) – If you make a late payment, your score will take a hit. The more recent, frequent, and severe the lateness, the lower your score. Bankruptcies, judgments, and collection accounts have a serious negative impact. Conversely, making your payments on time will boost your credit score.
- Amounts owed (30%) – Carrying large balances on personal loans and revolving debt, like credit cards, particularly if those balances are close to the credit limits, will lower your score.
- Length of credit history (15%) – The longer you have had your accounts, the better.
- New credit (10%) – This factor looks at the number and proportion of recently opened accounts and number of inquiries. While many inquiries on your report can lower your score, all mortgage or auto loan inquiries that occur within a short period of time are considered just one inquiry for scoring purposes. Accessing your own report is not damaging to your score nor are inquiries for pre-approval offers. If you have had a history of late or irregular payments, reestablishing a positive credit history will be taken into account.
- Types of credit used (10%) – Having a variety of accounts, such as credit cards, retail accounts, and loans, boosts your score because it demonstrates that you are capable of handling the responsibilities that come with each debt type.
Keep in mind that while the FICO score is a popular scoring model among lenders, a lender may use a different model when you apply for credit. Furthermore, if you purchase your credit score from a credit bureau or other service, you may be purchasing something other than your FICO score. Still, while the exact formula and scoring range can vary among models, they generally look at similar factors. Making your payments on time and keeping your balances low is always beneficial, regardless of the scoring model used.