Understanding Credit Scores
The impact of your credit score on your mortgage loan.
A credit score is a number between 350 – 850 on a scale created by the Fair Isaac Corporation (FICO). This number is known as your FICO® score, and it is used by lenders as a snapshot of your credit history and a summary of risk involved to lending to you.
- A higher FICO score equates to less possible risk to lenders, and generally a lower interest rate to you as a borrower.
- A lower FICO score equates to more possible risk to lenders, and generally higher interest rates to you as a borrower.
Your FICO score can easily be your best possible asset to obtaining home financing at competitive rates, or it can be an obstacle to securing a loan or credit.
Your credit score matters. When you apply for a home loan with American Pacific Mortgage, we will check your credit score for you as part of the pre-application process. What factors go into determining a credit score?
Your credit score changes as new information is updated in your credit report. There are five primary factors that determine this constantly updating score. Here is what the credit reporting agencies are looking at, and what you can do to optimize your score.
Payment History – 35% of Total Score
Late payments can have a negative impact on your credit score. Recent late payments will result in more lost points than older late payments, since this factor is weighted to the most recent activity. The frequency and severity of late payments will also come into play; a 90-day late is considered worse than a 30-day late payment. Over time, your older late payments will have less of an impact on your credit score, since your most recent payment history is a better reflection of your credit risk. Optimize your credit score by making sure all bills are paid within 30 days of the due date.
Utilization Rate – 30% of Total Score
The ratio of your credit balance to your available limit is known as the utilization rate. The utilization rate of your individual cards and cumulative limit of all your cards are taken into account when considering your credit risk. Your credit score may improve when your balance to limit ratio is below 30%, and you may lose points for balances exceeding 30% of your limit. Optimize your credit score by paying credit cards down below 30% of their limits, or by requesting an increase in your limit to improve your utilization rate.
Length of History – 15% of Total Score
An established credit history is favorable when considering your credit risk. Your credit accounts have an overall age that goes up and down over time as you open new accounts. Opening new accounts will reduce your overall credit age, and will generally lose you points the first 12 months after a new account has opened. The next 12 months an account is neutral on your credit report, and will start to earn you points after 24 months of on-time payments. Optimize your credit score by keeping your older accounts open – even if you have paid that card off. Unless a paid off account is costing you in annual fees, it is providing positive points as an established account. Try to use that card at least once every 6 months to keep the account open and active, and then maintain your good history with on-time payments.
Type of Credit – 10% of Total Score
To maximize the points on your credit score, creditors like to see a mix of account types. A good mix of account types demonstrates your credit worthiness and a reduced credit risk. Different credit types include installment loans, such as mortgages and auto loans, and revolving credit (credit cards). Optimize your credit to get the highest scoring in this category with one major installment loan (mortgage or HELOC), one additional installment loan (auto), and a minimum of three revolving accounts. Mortgage paid off? No problem. A home equity line of credit (HELOC) can be a smart tool to optimize your credit score. Use a HELOC for any number of expenses and pay it off the following month.
Inquiries – 10% of Total Score
Each year, you can request a free copy of your credit report from the major reporting agencies. This sort of inquiry is considered a “soft” inquiry, and has no negative impact on your score. Credit inquiries requested from an employer with your permission also fall within this soft category. The type of credit inquiries that will impact your credit score are “hard” inquiries. A hard inquiry occurs when a lender pulls your credit. If you are applying for new credit cards from multiple lenders in a short period of time, each inquiry counts as an individual hard inquiry, and will result in lost points on your credit score. However, if multiple lenders pull your credit for a single new account, like a mortgage, all of these inquiries are counted as one hard inquiry. Optimize your score by sharing personal information only when necessary to complete a borrowing transaction, and limit the amount of accounts that you apply for at a time. Inquiries will reduce your score for 12 months, but remain on your credit report for 2 years.