Understanding Credit Scores (Pt 1)
Even though a borrower’s credit score is not the only criteria that lenders look at when considering a loan approval, it is essential that borrowers do everything to keep their scores healthy.
A borrower’s credit score is drawn from a FICO® based scoring system that was developed for the mortgage industry by Fair Isaac & Company over two decades ago. Scores can range from a low of 300 to a high of 850, and are based on a scoring methodology that looks at five key factors.
According to FICO about 35% of the credit score is based on a consumer’s payment history. This could include credit cards, retail accounts, installment loans and mortgages. Factors considered are how late were the payments, how much was owed, how many late payments and how recently they occurred.
Another 30% of the total score is based on amounts owed by the borrower. FICO looks at the amounts owed on all your accounts, the number of accounts with balances, and how much of the available credit is being used. The more a consumer owes compared to their credit limit, the lower their score will be.
The length of the credit history determines another 15% of the total score. Just as it indicates, what counts here is how long the accounts have been established.
The next 10% of the total score focuses on new credit. If the borrower has recently applied for or opened new credit accounts, the credit score will weigh this fact against the rest of the borrower’s credit history. FICO scores distinguish between a search for a single loan and a search for many new credit lines, in part by looking at the length of time over which inquiries occur. If a borrower needs a loan, they should do the rate shopping within a focused period of time, such as 30 days, to avoid lowering the FICO score.
The last 10% of the score deals with the types of credit the borrower has. FICO looks at the mix of installment loans, mortgages, retail accounts, credit cards and finance company accounts. Continued in the next blog.