March 10, 2016
If you’re thinking of buying a house, you already know that having good credit is, well, a good thing. But what is a good credit score? And what goes into determining it exactly? Here, we’ll delve into the mysterious but oh-so-important number.
A credit score is a number derived by a mathematical algorithm that gives creditors an idea of the risk level associated with loaning you money. The higher your score, the lower the risk that you’ll default on your credit obligations. Your credit score greatly affects whether or not you’ll be approved for a credit card or just about any kind of loan—except maybe one from a rich uncle. It also controls how favorable the interest rate and terms of the loan are. Suffice it to say, it’s pretty darn important.
Not To Scale
There’s a reason why credit scores are sometimes hard to understand from a consumer’s perspective: credit-reporting bureaus don’t all use the same credit score scale. For example, the scale from FICO (Fair Isaac Corporation), which is used by 90 percent of the top lenders according to their website, ranges from 300-850. TransRisk, another credit-reporting company, uses a scale of 100-900. As you might imagine, a score of 750 is going to be more favorable on FICO’s scale than on TransRisk’s. When reviewing your credit scores, make sure you know which credit company’s number you’re looking at and what their credit score range is.
Breaking Down The Magic Number
So let’s look at what goes into a credit score. Events on a credit report are divided into five separate categories in the ever-popular FICO score, each carrying a different weight. Events within the report are calculated as either negative or positive activity. The breakdown of the FICO score according to the weight of the data is as follows:
- Payment History (35%)
- Amounts Owed (30%)
- Length of Credit History (15%)
- Credit Mix (10%)
- New Credit (10%)
Payment History is the account payment information including any delinquent or steady payments, as well as any public records in regards to the account.
Amounts Owed is the amount of credit a person is currently using across all of their accounts.
Length of Credit History includes how long each account has been open and how active the account has been in its lifetime.
Credit Mix refers to the types of credit that appear on a report, including revolving credit or installment credit.
New Credit is a measurement of a person’s request for additional credit, including credit checks and new accounts.
Credit scores are specific to each person and their credit history. According to FICO, “The importance of any one factor in [a] credit score calculation depends on the overall information in [a] credit report. For some people, one factor may have a larger impact than it would for someone with a much different credit history.” Translation: just because your friend missed a couple car payments and couldn’t get approved for a home loan doesn’t necessarily mean you’ll have the same outcome given a similar scenario. Other factors are always at play.
Nevada Housing Division’s homebuying programs use FICO’s credit score scale. Most of the programs we offer require a minimum score of 640 on FICO’s scale of 300 to 850.
Building Or Rebuilding Your Credit
If you’ve checked your credit score lately (and we hope you have!), but it’s not as high as you’d like it to be, do not despair. There are ways to build up or rebuild your credit, including employing the expertise of debt counseling and legal services. Epic Credit Solutions located in Reno, Nevada, has a team of FICO certified credit consultants and licensed attorneys to help with credit restoration. Financial Guidance Center, with offices in northern and southern Nevada as well as in Utah, teaches financial literacy and creates debt management plans to help people achieve their financial goals. These are just a few of the many resources available to help you get that magic number where you want it to be.
The biggest piece of advice we can give is to start building or rebuilding your credit before you think you need to. It does take time for positive activity to positively affect your credit score, but your efforts will pay off.
For more information, we recommend visiting http://www.myfico.com/. The site is a wealth of information. (Pun intended.)