Your credit score is a number lenders use to determine the risk of lending to you. Credit card companies, auto dealerships and mortgage bankers are a few of the type of institutions that will assess your credit score before deciding if and how much they are willing to lend you and at what interest rate.
The three major national credit bureas, Experian, Equifax, and TransUnion, create detailed credit reports for lenders from which credit scores – also known as FICO® scores – are compiled. Credit scores are affected by these five factors:
Payment History – 35%
Are you making your payments on time? This is the most important component of your credit score. Payment history is an indication of your ability to repay money that is lent to you. Payment history considers credit cards, retail accounts, installment loans and mortgage loans.
A few late payments do not automatically destroy your credit score if your overall credit history is good. Bear in mind, however, that your FICO® score will reflect how late your payments were, how much was owed, how recently late payments occurred and how many late payments there were.
Amounts Owed – 30%
How much do you owe on your credit accounts? Owing money doesn’t necessarily mean that you are a high-risk borrower. Nonetheless, when a high percentage of your available credit is in use or “maxed out,” this can alert lenders that you might be a borrower who is financially overextended and more likely to miss a payment.
Your FICO® score also considers the amounts you owe on specific types of accounts, such as credit cards and installment loans. Installment loans are the type of loan which must be paid back through regularly scheduled payments (or installments). Installment loans are reviewed by the amount of money that was borrowed compared with the amount that has been repaid.
Having a low credit utilization ratio—that is, not borrowing as much as you could potentially borrow—usually results in a higher FICO® score.
Length of Credit History – 15%
Typically, a longer credit history will increase your credit score; but this can vary depending on the previously mentioned factors. Your FICO® score considers how long your credit accounts have been established (including the oldest and newest accounts as well as the average age of all your accounts), how long specific types of credit accounts have been established and how long it has been since you used certain accounts.
Types of Credit in Use – 10%
FICO® scores are affected by the types of accounts you have. Do you have experience with both revolving credit (such as credit cards and retail accounts) as well as installment loans (such as money you’ve borrowed to buy a home or a car or to pay for college or university), or have you been limited to one type of loan?
Your FICO® score will reflect the number of accounts you have open. There is no perfect amount of credit accounts, as it will vary person to person based on their overall credit picture.
Keep in mind that a closed account will continue to show up on your credit report and that your track record with that lender is still considered by your FICO® score. Even if there’s a credit card that you do not use anymore, it is advantageous to leave that account open with a zero balance.
New Credit – 10%
Research shows that borrowers who open or apply for multiple credit accounts in a short time period are riskier borrowers. Your FICO® score represents how you shop for credit.
When a lender makes a request for your credit report or score, it is called an inquiry. Every time you apply for credit, an inquiry will be made; and every inquiry will remain on your credit report for two years, though FICO® scores only take into consideration inquiries within the preceding 12 months. Applying for multiple lines of credit in a short amount of time can affect your credit, but the impact varies from person to person based on the applicant’s credit history. It is generally a good idea to refrain from opening new accounts before applying for the financing of a large purchase, such as buying a home.
What Makes Our Credit Check Different
If you are wishing to make a home purchase now or in the near future, don’t rely on the scores given by online credit checks. When Compass Mortgage runs your credit score, we gather all three FICO® scores from Experian, Equifax and TransUnion. We then take the median score of the three to represent your score throughout the mortgage process.
Online credit checks typically only represent one of your three scores and could misrepresent where your credit stands for mortgage financing. Only knowing one of your scores could mislead you to think that your median credit score is higher or lower than it actually is.
If you are interested in making a home purchase in the near future, download our Mortgage 101 Handbook for a go-to reference on the home buying process.