How is Your Credit Score Determined?
One of the most important factors in the interest rate you receive on your mortgage is your credit score. Yet most people don’t know what factors affect their credit score, or by how much. Becoming a bit more knowledgeable about how your credit score is determined could save you thousands of dollars over the course of your mortgage.
Not only do lenders look at your credit score – they also check credit history. Specifically, lenders, loan originators and underwriters want to make sure you have enough history that they feel you are credit worthy. Credit score, on the other hand, is defined as the likelihood of an individual going into default over the next 30, 60 or 90 days on any credit account.
Credit scores range from 350 – 850. The pie chart below shows you how your credit score is determined. Discussing the breakout of each of these categories will allow a better understanding of how your credit score is calculated and how you can improve it. What follows is a very basic description intended to give good general answers:
- 35% (the biggest percentage) of your credit score is based upon payment history. This category tells lenders if you’ve made payments on time. If you have, then there’s nothing to worry about in this area – but any recent late payments will greatly impact your score, since over 1/3rd of your rating is based on this category alone.
- 30% (the 2nd biggest percentage) of your credit score is based upon amounts owed. This category can be the simplest to understand, yet most people aren’t aware of it. It can also be one of the easiest items to fix on your credit report. This category looks at how much you’ve charged on each revolving credit account, and compares that to your credit limit in the form of a percentage. So to get the best rating in this category, you’ll want to keep your credit card balances below 10% (or 30% at most) of your credit limit. The closer the balance is to your credit limit, the lower your credit score will be – and the closer the balance is the zero, the higher your credit score will be.
- 15% of your credit score is based upon the length of your credit history. This is another straightforward category, and basically means “The longer you’ve had credit, the better” So, all else being equal, someone with 20 years of credit should have a higher credit score than someone who just opened their first credit account 1 year ago. The moral of the story is this: don’t chase credit offers for lower interest rates unless you absolutely need to, as your score will improve the longer each individual credit account remains open.
- 10% of your credit score is based upon new credit or credit inquiries. Many argue that you should not have a lot of credit inquiries – but this isn’t always true. If the inquiries are the result of your applying for, and receiving, a new credit account, that’s okay. On the other hand, receiving many inquiries while not gaining any new credit on your credit report will hurt your score.
- The last 10% of your credit score is based upon types of credit in use (revolving or credit cards, installment loans, mortgages, & finance). Specifically, you don’t want to have all your credit accounts consisting of one type of credit, but rather a good mix of all 4 types of credit accounts.
Each of the categories just described can have much more to it, depending on your individual situation. Still, understanding the basics of how your credit score works will help you to obtain the best interest rates in today’s market