Now that we’ve covered the Credit Score System basics – including what a credit score is and the different categories, let’s review your rights as a consumer, how they are calculated, and tips for getting and keeping the highest credit scores.
Consumers Rights
Until recently, many people didn’t even know this number existed because it was closely guarded secret in the lending industry. In fact, lenders were prohibited to tell borrowers what their credit scores were. Lenders believed that if people knew their score, they would be able to change their behavior and manipulate the score rendering it useless.
That all changed in 2000 when online lender E-Loan offered to give consumers their scores for free and explained how they were calculated. Fair Isaac (FICO) cut off E-Loan from getting credit…E-Loan stopped giving out the scores. However, public outcry of erroneous information led to legislation which led to a more open environment. And today, not only can that information is bought everyone is entitled to a free credit report every 12 months from the 3 main credit bureaus…Equifax, Experience & Tran Union.
How it’s Calculated
There are more than 20 different factors that are divided into 5 different categories that go into making up your credit score.
- How you pay your bills (35%)
The most important factor is how you have paid your bills in the past with the most emphasis on recent activity. Paying your bills on time is good. Paying them late on a consistent basis is bad. Having accounts that went to collections is worse. In bankruptcy is considered severe.
- Amount of money you and vs. amount of available credit (30%)
The second most important area is your outstanding debt – how much you owe on Credit Cards, Mortgage, Cars, Home Equity Lines etc. compared to how much credit you have available. If you have 10 credit cards each with a credit limit of $10,000 that’s $100,000 in available credit. Carrying credit isn’t bad. Carrying close to the maximum is very bad. By the converse, not using your credit isn’t good either. Statistically, people who have a lot of credit tend to use it which makes them a less attractive risk. Those with the highest scores use their credit sparingly and keep their balances low. As a rule of thumb keep your balances to 40% of your credit limits or lower.
- Length of Credit History (15%)
The longer you have had credit, the more points you get. Reason being is there is a longer period in which to determine your credit worthiness
- Mix of Credit (10%)
The best scores have a mix of revolving debts…credit cards…AND installment debt…mortgages & car loans. Statistically the richer the variety of experiences, the better the risk because they prove they know how to handle money.
- New applications / Inquiries (10%)
How many applications are you filling out? The system does compensate for people who are shopping. However, if you have recent credit stumbles combined with recent inquiries, the inquiries will work against you.
What Doesn’t Count in a Score?
- Age
- Race
- Sex
- Job or length of employment
- Income
- Education
- Marital status
- Whether you have been denied credit
- Length of time at address
- Whether you own or rent
- Information not contained on your credit report
* Lenders may/will consider some of above, but your score will not be affected.
The Credit Score System is not Perfect
The major draw back is the system is only as good as the information is accurate on your report. More than likely, there will be errors. It’s generally recommended to check your credit annually or 3+ months prior to a big purchase like Mortgage or Car. This will give you time to address any errors or make changes to your borrowing habits.
Rules of Thumb
- Think of your credit score like a muscle, the more you work it out, the stronger it will get
- Remember that it’s the ability to borrow and the wherewithal to pay off. Borrow responsibly, pay on time and maintain low balances.
- Check your credit in advance for large purchases.
- Time will heal all wounds. If you have had poor history in the past, make sure you focus on having more recent good history.
- It’s a snapshot of a moment in time and you will be evaluated by your score today, not yesterday. So no matter what your score is, remember it will change in the future. Handle your credit responsibly at all times and it will likely be the same or higher in the future.
If you have questions about the credit score system, or the mortgage process, the Kelly Mortgage Team at Envoy Mortgage is here to help. Give us a call at 610-355-1801 and we will work with you to meet all of your needs.