The most common credit score used by mortgage lenders in the United States is the FICO score. This score helps lenders determine a loan applicants creditworthiness and has a direct bearing on the terms that the lender is likely to offer any given individual. Generally speaking, the higher the FICO score, the lower the risk. This means that people with higher scores usually receive more favorable loan terms.
The industry secrets regarding how a FICO score is calculated is top secret. Fortunately, the company has allowed consumers a glimpse of the process by giving a list of what sorts of information they use and how they use it in analyzing and scoring a persons credit. This knowledge can help individuals clear up bad credit or appeal false information, and handle their available credit appropriately. Here is a list of the information the FICO Corporation uses and how it is weighted in their formula:
Payment Habits: Everyone knows it is important to make payments on time, and now you know why: this is 35% of your overall FICO score. Slow payments lower your score and conversely on-time payments raise the score.
Credit Used and Available Credit: This is an important ratio to a lender and it makes up 30% of your FICO score. Having plenty of available credit will raise your score. Also, paying down loans regularly but not closing them, and paying down your open revolving credit cards will increase the score. However, closing revolving credit accounts will lower the score.
The length of a persons credit history is the third most important factor, weighted at about 15% of ones FICO score. Since the FICO score is meant to help the lender predict how the consumer will behave with the loan, the more of a credit history the borrower has, the more likely it is that past behavior will be indicative of future behavior. Therefore, the longer ones credit history is, the higher the score will be.
Types of Credit and Recent Credit Inquiries: These two factors make up the last 20% of your score, or 10% each. There are different kinds of credit available to consumers and FICO looks at how an individual has handled these. If there are different kinds of credit that has been handled successfully then it raises the score. The number of recent credit inquiries can give a picture of a persons current financial situation. If there are a lot of inquiries into someones credit the score will go down.
This outline should go a long way towards helping the consumer understand how their credit score, and specifically their FICO score, is calculated; it should empower consumers to act wisely, increase their FICO scores, and be rewarded with better terms for their loans.
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