What Does My Credit Score Mean?
Learn how your score is calculated, what factors go in to your credit history, and how to use that information to your advantage.
- A Credit Score is weighed differently from industry to industry but the most popular is a FICO score.
- Payment history, revolving debt, credit history, credit inqueries and types of credit are contributing factors to your credit score.
- Do try to keep your revolving credit to 30 percent or less of the available credit.
- Do not open any new lines of credit before applying for a loan.
WHAT IS A CREDIT SCORE?
By definition, a credit score is a mathematical formula that evaluates many types of information in a credit file. It is used to evaluate whether a person is likely to make their payments on time. Being able to determine that likelihood is what allows lenders to stay in business. The higher your credit score, the less the risk for the lender, which means a lower interest rate and better payment terms for you as a borrower.
WHAT FACTORS INTO YOUR CREDIT HISTORY
Let’s dig in to the different factors that affect your credit history. This will help you understand what is being weighed in your score. These factors can vary from industry to industry, but we will look at the most popular score used by mortgage companies: FICO.
FICO scores are weighted as follows:
35% Payment History: Recent delinquencies, frequency of delinquent payments and the severity of delinquent payments all weigh in on your history. One or two missed payments over the course of several years might not make a big dent in your score, but consistently being late on your commitments does.
30% Revolving Debt Ratio: These types of credit are typical with department store, gas station and bank credit cards. You are given a spending limit on each card by the lender, and as you pay your monthly bill, a portion of your payment (less interest) is “returned” to your account for your use. This recycling game can go round and round eternally. A mortgage lender determines not only how much income you have coming in, but how you are managing expenses like these. If you are spending more than 30 percent of your income on revolving charges, a lender may assume that you are caught in a debt cycle you can’t get out of. If you are typically at the maximum of your credit limit – paying only the minimum balance due each month – you can very quickly end up in the never ending cycle of debt.
15% Credit History: How many credit cards do you have open and how long have those accounts been active? If, for example, you have a store department credit card that you hardly ever use but it has a credit limit of $1,000, then the mortgage lender looks at it as if you could possibly have another $1,000 in debt to pay off. Having those types of open credits can go in your favor in you’ve had the accounts for awhile and have been paying off the balance each month or keeping a small balance. But mortgage companies are aware of the fact that people sometimes go on spending sprees when they are buying a house (we all want new things in our new homes)! Be careful that you don’t make any big charges before you sign the mortgage papers.
10% Inquiries: Only apply for credit when you need it. You probably don’t need a dozen credit and store cards. For mortgages, a lender typically allows 7-10 inquiries for the preceding 12-month period. If you have more than that, they will start wondering why you’re applying for so much credit. Are you using Peter to pay Paul? Are you overcommitting yourself?
10% Types of Credit: Mortgage companies want to see a balanced portfolio of credit in order to grant you a loan for what is probably going to be the largest purchase of your life. A good balance of credit is what you could expect a typical working person to have – a car loan, one or two credit cards, a history of utility bills paid on time, etc. The mortgage companies want to see that your payment history is stable for both long and short-term commitments.
HERE’S HOW TO USE THE INFORMATION:
Now that we’ve given you the basic understanding of what factors go into calculating your credit score, here are some things you can do to help make sure your credit score is working IN your best interest instead of AGAINST it:
- Know your credit make-up, ask questions and know your consumer rights.
- Pay all of your bills on time, every time.
- Keep the balances on your revolving credit cards to 30 percent or less of the available credit.
- Monitor your credit score for inquiries.
- Late payments sometimes happen no matter your credit rating. Ask your creditor for a one-time courtesy to remove reporting of a late payment if this happens to you.
- Have at least one active major revolving account, like a bank credit card.
WHAT NOT TO DO:
- Do not borrow from high risk finance companies. If you need money quickly for something unexpected, it’s better to take it from your savings account or borrow it from a friend or relative if necessary.
- Do not close revolving accounts. Although it may sound contrary, talk to your lender before closing any unused cards. This may send the wrong signal that you are in financial distress.
- Do not open any new credit before applying for new loan. A series of credit openings again signals the possibility of a financial stress situation.
Attaining and keeping a good score is vital to most of us in order to get the material things we want. Knowing how you can improve your credit score and keeping track of it are two of the most important things you can do for your economic security.