- © Score More Credit
Credit Score Issues - Part IIMortgage and Home Equity LoansWhen you apply for a mortgage, nearly every lender will pull your FICO score and credit report from each of the three bureaus and use the middle score as defined above. This middle score determines the interest rate you will pay on your home loan. For mortgage lenders, a score of 620 is required to be considered conventional and creditworthy. A score of 670 or higher is excellent. That 50-point difference in credit score can make a tremendous difference in your interest rate. If a credit score of 675 can get you a 6.4% interest rate, a 720 score will give you a rate of 5.7%. That's an annual difference of $7 on every $1,000 you borrow. FICO Score BreakdownYour FICO score can be broken down into five major categories. Each categories have a number of elements of what makes up that portion of your score. Note the relative weight of each category in the chart below.
Your financial responsibility as shown through your history of on-time payments is the biggest ingredient in your credit score. Up to 35% of your total score can be represented by this factor. FICO scores were developed primarily to assess the risk of you defaulting on your loan in the first 90 days. Lenders will want to be assured that you pay all your bills on time. Although the last seven years are calculated, the more recent the late payment, the greater impact it has on your score. Late payments on mortgage and home equity loans carry greater weight than late payments on other installment loans or revolving lines of credit. Weighted amounts owed, or credit utilization, makes up the next 30% of your score. This is the amount of credit you use each month, compared with the amount of credit you have at your disposal. For revolving credit, the FICO score takes the ratio of the credit limit vs. your current monthly balance. For installment loans like an auto or home loan, FICO takes the ratio of your original loan to your outstanding balance. This is why a new home or auto loan may lower your score for the first year. Revolving credit counts more towards this score than installment loans. Your ratios fluctuate every month, since your revolving credit changes every month. These fluctuations in utilization are the primary reason that your credit score changes a few points every time someone looks at your credit. The length of your credit history or longevity accounts for 15% of your score. This is about half as great as the impact of credit utilization. The longer your relationship with your lenders the better your score will be. Since unused credit accounts don't hurt you, never close a credit account. The long history will improve your credit, and this factor only gets better with time. The next 10% of your score weighs your credit versatility or diversity— how well you have managed different kinds of debt. The lender will want to see that you have had installment loans and revolving lines. The ideal combination is a school loan, mortgage, auto loan and credit card. However, two credit cards or a home loan and rental property loan are almost as good. The remaining 10% of your score is comprised of a number of factors including the number of open accounts, the existence of accounts from consumer finance companies, the number of accounts with balances, and the number of inquiries into your credit. One of the most controversial areas of controlling your credit has to do with the effect on your score of credit inquiries. On one hand, a pull of your credit will decrease your credit score. There is no question of that. However, you can see that the number of pulls is only one of several factors that can affect only 10% of your score. Thus your credit score is only affected in a way that has any real impact if the remaining elements of your credit score are close to perfect. Additionally, credit scores are calculated in such a way to reduce the effects of rate shopping, such as when you are looking for an auto loan or mortgage. Credit pulls that occur within a short period of time are usually lumped together and calculated as only one hit. Knowing this, there are two ways to prepare yourself. First, you can obtain your own copies of your credit report. When you obtain your credit report yourself there is no negative effect to your score. You can use this copy when you are shopping for a mortgage, auto loan or apartment lease. Tell your prospective creditor that the report is recent and accurate, and that you will authorize them to pull their own copy if you decide to do business together. Your second strategy is to plan your credit inquiries so that they fall within the same one-week period of time. If you are planning on shopping for an auto at the same time you'd like to take advantage of some credit card offers, do them both in the same week so that the credit inquiries are lumped together. Auto LoansThe scores for auto loans follow pretty closely to the scores for home loans. This is because they are both installment loans and function in largely the same manner. Because a new car is less security for a loan than real estate, auto loans often require even higher credit scores. In fact, the average credit score required by the auto industry has been on the rise in the last few years. Their desire for better credit risk is reflected in their rates. Even a few points makes a tremendous difference. Recently a credit score of 720 resulted in a 5.65% interest rate, but a 730 score would get a 4.96% rate. Credit cardsThe scores for credit cards are heavily weighted towards your on-time payments and credit history with revolving accounts. Credit card target scores are hard to predict. Credit card companies vary their target interest rates and decisions to extend credit as much as a result of their internal goals and conditions as the strength of the borrower. Most credit card companies review the credit of their customers quarterly and adjust the interest rate depending on your credit score as well as their default rates and need for income. If you've recently taken out a new mortgage or home equity loan, the card issuer may decide that you are now a greater default risk and hike your interest rate. InsuranceYour FICO score also impacts the premium you pay on your insurance, and in some cases, whether you will be insured at all. The better your credit history, the less likely you will be to file a claim against your insurance. Not that you are a better driver—just less likely to file a claim. Bad credit puts you into the group of people that are more likely to file an insurance claim when they have an auto accident. Your insurance risk score differs greatly from your FICO score. Insurers focus far more on the length of your credit history and years at your present location. Insurance scores are weighted towards your stability. Most major insurance companies develop their own proprietary insurance score. Some states have banned the use of credit scoring to underwrite insurance policies. Other states have prohibited insurers from relying solely on credit scores to determine their premiums. Your driving record and the number of claims you've made against your home insurance are just as important as your insurance risk score in determining premiums. |
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