Credit Scoring

The credit system in place today is fast.  A credit report and score can be obtained by a creditor within seconds. Generally used for lending, it is the basis for approving or denying loans.

 

The credit score came along in the early 1990’s when Fannie Mae approved the FICO credit score to be used in mortgage approvals and it saved hours per loan application in terms of approving or denying a loan request. the FICO credit score ranges from 300 - 850, higher is better, being at a 740 or higher will almost always get you the best terms on a loan.

 

The three big credit bureaus (Experian, Equifax, and TransUnion) provide credit reports which contain information on a consumer’s current and past accounts, including details such as amounts owed, payment history, length of time the account has been open, etc.

 

The Five Factors of the FICO Scoring Model:

 

1. Payment history - 35% of the score. Paying accounts on-time is the largest factor for credit scores. An account is considered on-time as long as the payment is received within 30 days of the due date. One day past the due date may be considered LATE in the eyes of the lender.

 

You could be subject to a late charge, but if it is received before it is 30 days past due it will not affect your credit scores. Could a lender report an account that was one day past due as being late to the credit bureaus? Absolutely. Will they? Not likely. It is an accepted practice by lenders to report only payments that are 30 days late.

 

2. Balances owed accounts - 30% of the score. The balances we carry have an impact on the credit scores, coming into play mostly with revolving accounts such as credit cards. The rule of thumb is that you should try to keep your balances on credit cards less than 50% of  the available credit limit. The closer you get to the limit on an account the more likely you are to  see a decline in credit scores. Try to keep your credit card balances as low as possible, lower is better.

3. Length of credit history accounts - 15% of the score. The longer the positive credit history the better. An installment loan has a set lifespan and will be closed when the last payment has been made. Conversely, credit cards (revolving accounts) can have an infinite lifespan.

Contrary to popular belief, closing accounts is not a  good thing when it comes to credit scores. If you cannot withstand the temptation to accumulate more  debt on open credit cards, put them out of immediate  reach (safe deposit box) to avoid spontaneous  purchases. Try to avoid closing out history you have  already earned.

4. New credit accounts - 10% of the score. Inquiries and new accounts fall into this category. Every time a lender gets your credit report or credit score it shows up as an inquiry on your credit report. An inquiry can have a small impact on your credit score, maybe a decline of a point. Gaining a new credit account can have a larger impact on your credit score in the short term. Do not apply for unneeded credit.

5. Mix of credit accounts - 10% of the score. An ideal mix of credit would be credit cards, car loans, mortgages, student loans, etc. Someone with only credit card accounts and nothing else may be at the most risk. Keep in mind - the “mix” is only 10% of the overall formula.

Have a mortgage or credit question you would like for me to cover on this blog? Shoot me an email so I can address it. If you want to apply for a mortgage in Arizona give me a call at 480-203-4641, the application process is easy, and it only takes 10 minutes for me to get the information to get you started on your way to home ownership.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

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