What is a Credit Score?

What is your credit score, and what does it mean when it comes time to borrow on a home loan? Simply, a credit score is a statistical method of predicting and evaluating if your loan will perform to the lender’s satisfaction. Your score is a single number ranging from a low of 300 to a high of 850, and is calculated using your past credit history as well as other factors, such as the types of lenders you borrow from.

FICO Score Graph

Generally speaking, the higher your credit score, the lower the rate a lender will offer you on a home loan. It pays to ensure your credit profile is updated and accurate before you apply for a home loan.

The Fair Isaac Company developed the concept of credit scoring. It is commonly known as a FICO Score. As the developer of the model, Fair Isaac considers its scoring model proprietary, and as a result the exact credit variables are confidential.

Each of the three major credit bureaus (Equifax, Trans Union, and Experian) calls its FICO score something different, but their score represent the same thing to all lenders using it to make a loan or credit decision.

Here is a chart of the range and distribution of credit scores nationally

FICO Scores

Mortgage lenders more closely scrutinize loans with credit scores between 620 and 660, since it is known that these loans have a greater likelihood of default. Lenders may ask for additional documentation or explanations before approving the loan. They will also look at other factors, such as accumulated assets, down payment, loan type, and percentage increase in housing expense or debt ratios when evaluating loans with lower FICO scores.

Borrowers with credit scores below 620 may find it challenging or impossible to arrange mortgage financing until they take positive steps to improve their scores. Simply ignoring the problem will not improve your scores.

The nations largest mortgage buyers, Fannie Mae and Freddie Mac, utilize credit scoring as part of their automated underwriting loan approval process. Although credit scores are only one part of the automated system, there is a strong correlation of loan approvals to the higher scores.

Credit scores are very good predictors of how a loan will perform, but there are some important limitations. First, credit scores are derived solely from “raw”, unverified data as reported the three major credit bureaus. Consequently, if a borrower has a number of derogatory items on their credit history that are reported in error, or delinquent accounts that were recently settled, it means that the score will remain low until the information is eventually updated or purged. Without knowing how the scoring model works, the mortgage lender has no control over the final reported score.

Lenders look at more than just your score. Things like outstanding court judgments, delinquent child support, defaulted student loans and tax liens can negatively impact a borrower’s ability to borrow for a home. Even with an acceptable credit score, these will need to be resolved before a loan can be approved.

There are 33 variables to the credit-scoring matrix that predict the borrower’s ability and willingness to repay a loan. These variables are grouped into one of five categories:

  • Current level of debt as compared to available credit.
  • Active seekers of new or additional credit
  • Type of credit being used, such as finance companies.
  • Payment performance on previous accounts.
  • Amount of time the credit has been open.

You Have More Than One Credit Score:

In general, when people talk about “your score”, they’re talking about your current FICO score. However, there is no one score used to make decisions about you. This is true because:

  • Credit bureau scores are not the only scores used.
    Many lenders use their own scores, which often will include the FICO score as well as other information about you.
  • FICO scores are not the only credit bureau scores.
    There are other credit bureau scores, although FICO scores are by far the most commonly used. Other credit bureau scores may evaluate your credit report differently than FICO scores, and in some cases a higher score may mean more risk, not less risk as with FICO scores.
  • Your score may be different at each of the three main credit reporting agencies.
    The FICO score from each credit reporting agency considers only the data in your credit report at that agency. If your current scores from the three credit reporting agencies are different, it’s probably because the information those agencies have on you differs.
  • Your FICO score changes over time.
    As your data changes at the credit reporting agency, so will any new score based on your credit report. So your FICO score from a month ago is probably not the same score a lender would get from the credit reporting agency today.

So how do you increase your  credit scores? It depends on your individual situation, but here are a few ideas that may make an immediate impact:

  1. Review your credit report on a regular basis for errors and take steps to update or correct those errors by contacting the creditor and the 3 credit agencies. Be prepared to document your case.
  2. Pay all of your obligations in a timely manner, with no late payments.
  3. Keep your revolving balances to less than 33% of the maximum credit line at any given time. This means paying down your credit card balances.
  4. Pay off all outstanding collections, judgments and tax liens. Keep proof of payment and any releases.
  5. Do not “dispute” credit accounts on your report. Disputing accounts does not increase your score, and can actually hinder or delay your loan approval.
  6. Keep all student loans and child support current. Student loan servicers and child support agencies report delinquent and defaulted accounts to all 3 credit bureaus.
  7. Finally, enlist the help of non-profit agencies such as Consumer Credit Counseling Services http://www.credit.org/cccs/ to help you with financial education and budget management.

Under federal law, you have the right to obtain a free copy of your credit report from each of the nationwide consumer reporting agencies once a year. To order your free annual credit report:

Telephone: 877-322-8228

On the web: http://www.annualcreditreport.com

By mail:

Annual Credit Report Request Service

P.O. Box 105281

Atlanta, GA 30348-5281

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