One of the most misunderstood topics among consumers is credit scoring. It’s interesting that it’s so misinterpreted given the degree that it can impact your life. That one number can mean the difference between being approved for that new home, car, or credit card, and the amount that you will pay to get it.
How credit scores are calculated
Credit scores run from 300 to 850 and are calculated based on a mathematical equation which calculates and weighs various items from your credit past. In the US, we use the fico equation developed by fair Isaac and company. All of your credit for the past 7 years (10 with certain types of bankruptcy) is complied and used to determine how good of a credit risk you are.
The equation has five main categories that grade your credit history with each category being weighted differently.
35% of your credit score is payment history
This is where on time payments will help you and late payments or collections will hurt you. Late mortgage payments will especially drop your score. Late payments are only reported once they are 30 days or more past due so if you miss that payment by only a couple days it shouldn’t hurt your credit.
30% of your credit score is how much you owe
Your debt may be a revolving trade line or installment loan. A revolving trade line is credit that has balances that can go up or down at anytime like a credit card. An installment loan is credit that has a set pay off, like a mortgage, car loan, or student loan. Keeping your balances low or paying down what you owe on these types of loans will increase your score. For good scoring keep your balances below 50% of the limit. For great scoring keep them below 30% of the limit.
15% of your credit score is credit history
For this category the scoring model looks at the age of your oldest account and the average age of all accounts. It also looks at how often you are using these accounts and how long it has been since you used them. Having a lot of old accounts is better than a lot of new accounts.
10% of your credit score is types of credit
Ideally what it is looking for is a healthy mix of credit such as one mortgage, one installment, one credit card, etc.
10% of your credit score is based on inquiries
Every time you apply for a loan or credit card and someone pulls your credit within the past 12 months it will show on your report and hurt your score . The reason inquiries are counted is because someone who is applying for a lot of credit within a short period of time indicates someone who could be over overextended and is not a good risk.
Note that if you check your credit yourself it is known as a ‘soft pull’ and will not impact your score. Also if you are rate shopping for a car or mortgage, any inquiries that are made within a 14 day period are counted as one inquiry.
If you are thinking about buying or refinancing a home and have a question regarding credit, please feel free to contact me
Chelsea Collier is a licensed home mortgage specialist in both Oregon and Washington, as well as a frequent contributing writer for OHM. Please don't hesitate to contact her with any questions you may have about financing (or refinancing) your home.