The Town Broker

Understanding Your Credit Score: 5 Key Components.

Understanding your credit score is never more important then when buying a home. We all know that the mortgage market is tighter than ever before. When applying for a loan, you will be asked to produce your credit report. And what your loan costs you is directly related to your overall score. So what exactly do lenders look at when calculating your credit score? Here’s what you need to understand.

Understanding The 5 Components In Your Credit Score

Basically, credit reports produce a score that tries to determine how likely you are to pay your bills. Most lenders run credit reports that uses a scoring model created by Fair Isaacs & Co. It’s known as your FICO score. This credit score is calculated by looking at the following things:

1. Your Payment History (35%). Do you always pay your bills on time? If you’re late on your payments, it will cost you. Your recent history weighs the most heavily
2. The Amount Owed/Available Credit (30%). What do you still owe on your charge cards? You car loan? And how much do you still have available on cards or your home equity line? Statistically speaking, people that have available credit are likely to use it. This is why having a lot of it is seen as a risk…just like having actual debt.
3. Length of Credit History (15%). How long have you managed your debt? The longer your history, the better you score.
4. Type of Credit Used (10%). Having a mix of revolving credit (like a charge card) and installment credit (like a car loan) makes you a better risk. It shows that you know how to handle money.
5. New Credit Applications (10%). How many new loan applications are you filling out? Often, people apply for new credit as a “last-ditch lifeline” right before declaring bankruptcy. So if you have some late payments and then apply for lots of new loans, it could raise some red flags. You should know however that the scoring models compensate for people “rate shopping” on big ticket items like cars or houses. In these instances, multiple inquiries in any 14-day period are counted as just one inquiry.  In addition, the score ignores all inquiries made in the 30 days prior to scoring.  (So if you find a loan within 30 days, the inquiries won’t affect your score while you’re rate shopping.)

What Is A Good Credit Score?

The FICO scale runs from 300 to 850. The majority of people will have scores that fall between 600 and 800. While lending requirements are a moving target, a score of 720 or better will usually get you the best interest rate.  According to Fair Isaacs, most American FICO scores break down according to the graph on the left. Do these scores matter? You bet!! According to BankRate.com, the interest offered to a buyer with a 520 FICO score and one with a 720 score can be over 4%!!

Go ahead and use this mortgage calculator to see what the impact is on your monthly payment. (It’s pretty BIG!!)

Want to know your credit score? Click here to get a free copy of your credit report.

Tags: Credit Reports, credit score

This entry was posted on Friday, June 11th, 2010 at 8:27 am and is filed under Distressed Property, Real Estate 101. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

1. AP said at June 11th, 2010 at 9:14 am

   Great Post Hal. I’m actually shocked to read how the FICO scores are broken down across America percentage wise that is. I mean if you look at the graph at a distance, you would think that the majority of Americans have fair to good credit. I guess my experience in the real estate business is different. By that I mean, in my market area, usually, 2 out of 8 buyers will qualify to buy a home, whereas the other 6 need to improve their credit before they can secure financing. I’m going to refer my clients to this post because I think you did a great job explaining how their scores are calculated. Until Next Time!. . .

2. halbenz said at June 11th, 2010 at 10:55 am

   Thanks, Angie. One of the big surprises to me was just how much an existing line of credit can hurt your score. I know folks who have lots of credit cards, but keep their balances low. It’s definitely better to limit the number of cards, and only apply for more as you need them.

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