Credit Score Overview
In the U.S. everyone’s credit histories are tracked and evaluated by the three major credit reporting bureaus.
Your credit history covers historical payment records, number of credit accounts you have, how much you owe (on each account), and your employment history. It also covers hard inquiries such as a bankruptcy, foreclosure, missed payments, etc.
Credit bureaus closely analyze your credit history and assign a number that represents the likelihood you’ll repay a loan – this number goes onto your credit report and is used by banks, mortgage lenders, landlords, etc.
Banks and car dealerships use your credit score to decide:
- If you should be approved for a loan
- How much they should loan you
- What interest rate should charge
- Chances you will default given your credit history
FYI: Banks and home mortgage lenders also have internal credit scoring models. This makes sense, since a mortgage broker will be more interested in various credit factors than a prospective landlord.
The Fair Isaac Corp. invented the credit-rating system in the late 1950s. You’ll likely end up with three different FICO scores, since each of the main credit bureaus may have slightly different information about you. FICO scores range from 300 to 850.
Credit Score Ranges
If your score is 700 or higher, your credit is excellent and you can borrow money at a low rate. A FICO score between 680 and 699 means your credit is good: you may not get fantastic rates, but you will get a decent loan.
If your FICO score falls between 620 and 679 your credit is merely OK. You probably can get a loan, but you’ll pay a higher interest rate. Below 600? Most lenders consider you a poor risk with a high probability of defaulting on a loan.
Having a credit score under 600 means you’re going to pay incredibly high interest for any type of loan – this includes credit cards, home mortgage loans, personal loans, and even home insurance.
In terms of home mortgages, here’s what you can expect for different credit score ranges.
Where Do Credit Scores Come From?
Every credit bureau uses a different algorithm to arrive at its ratings, but there are several things that greatly impact your credit score.
Factors that influence your credit score:
- How many credit cards and lines of credit do you have (Too many will lower your score.)
- How close to your credit limit you are on credit cards (Under 15% utilization ratio is best.)
- How much you owe on each credit account
- Late payments over 30 days (or debts in collection)
- How much interest you’re paying
- Disputes with lenders
- Filing Chapter 11 or 13 Bankruptcy
- Total debt
- Recent credit inquiries (Numerous inquiries in a short period may indicate financial trouble.)
- Mix of credit (Good vs. bad debt)
- How long have you lived in your home (ideally 2+ years)
- How long you’ve held your current job (best over two years)
How to improve your credit score:
- Make credit card payments on-time, and in full
- Keep your total debt low; pay down balances to 35% of your account limit.
- Limit yourself to no more than 4-5 lines of credit, including student loans, credit cards, and car loans.
- Avoid acquiring store credit cards, even if they offer discounts on purchases. These cards have low credit limits and will result in unnecessary credit inquiries.
- Keep your home and your job for at least two years.
- Avoid bankruptcy.
FYI: Income is not considered by the major credit bureaus when calculating your credit score. However, it definitely is considered by lenders and may have a critical impact on whether or not you get a loan. All other things being equal, the higher your income the likelier you are to get any type loan.
Get a Copy of Your Credit Report
You are entitled to one free credit report from each of the three credit bureaus every year, and this inquiry won’t affect your rating.
Although the reports are free, credit scores are not. If you want to know your score, it will cost you a small fee. Alternatively, you can buy your credit report and score directly from each of the credit bureaus, or ask your bank or mortgage broker.
Most online banking accounts also will provide a free credit report!
Experts agree that knowing and understanding your credit rating before you apply for a mortgage can make it much easier to negotiate. Remember, once you start a loan application it’s probably too late to do anything to improve your credit rating for that transaction.
Give yourself at least 6-8 months for your credit report to reflect improvements. You might end up with a credit rating that you won’t mind following you for the rest of your life.