Chicago, IL – The first installment of this series,  How to Understand and Make the Most of Your Credit Score – 1,  gave an overview of the credit system, and how good credit is more important than ever before for qualifying for a loan and getting the best interest rate. This installment we will go over Fico scores, one of the biggest factors in qualifying for a loan.

Your credit report contains a good deal of information but most lenders focus on one feature, the FICO score. The name FICO is short for Fair Isaac Company, the firm that developed it. Actually, there are 3 FICO scores, one from each repository, but we generally use the middle score. This score is a computer model that weighs the overall risk in your credit profile. The idea behind credit scoring is to measure the likelihood of a customer’s defaulting on a loan.

Credit scoring goes a long way toward taking the human out of the approval process and making the system more automatic. There are some big advantages to this. Because of credit scoring you can go to the local mall, apply for a credit card and automatically be approved for financing. It works the same way with mortgages. This is how we can offer same day full pre-approvals.

Fico scores range from a low of 350 to a high of 850 (the higher the better), but it’s rare to see scores at either extreme. Most people’s scores are in the 600s and 700s. Mortgage approval depends on other factors besides credit, but a high credit score will go a long way toward helping your situation. With risk based scoring you will need a score over 680 to get the best rates and pricing. If you are in the low to middle 600 range there are still options. If your credit score is below 620, you will have a harder time getting approved and the interest rate will be higher. The options available for those with scores below 600 are slim. Not so long ago Sub-prime mortgages filled this niche. Now your best option is to work on improving your score early.

Because your credit score is so critical to qualifying, it is important to check your credit early in the process, before you’re ready to even start looking for a home. This way if there are mistakes or problems, you have time to work on the credit and improve your scores.

There are five major factors that make up your credit score. These major factors are broken down into hundreds sub-factors, and how you measure up against all these factors is boiled down into your score. One thing to be aware of is that formula for the scoring changes regularly. This is meant as a way to measure the risk of default, so if new risk items show up in their reports, you can bet that the scoring will change. Lately I’ve seen scores vary more than usual, so my guess is they are adjusting the formula at the same time they are tightening the underwriting.

Here are the 5 factors, listed in order of importance:

Payment History: 35% impact. This seems obvious, but if you pay your bills on time it helps your score. Late payments, judgments and charge-offs can kill your score. If you miss a large payment it will hurt your score more than if you miss a low payment. Late payments from the last 2 years are more of a problem than older delinquencies.

Outstanding Credit Balances: 30% impact. This is a surprise for many people. You can have a perfect credit history and still have a poor score if your balances are too high. What they’re looking for here is how many accounts do you have open, and how high the balances are on the accounts. If you owe a lot of money on a lot of accounts, this is a risk that, in the future, you’re more likely to make your payments late, or not at all.

Your outstanding balance compared to your available credit limit is the issue here. If you are near your max credit limit it hurts your score. If you go over the max limit your score will take a big dive, because now not only is your balance too high, but you are now considered in default of the loan.

The less available credit you use the better. It helps your score if you spread your debt around several cards. Your score improves if you drop your balance below 50% of your limit, and it is best if you use no more than 30% of your available credit limit.

Credit History: 15% impact. How long have you had credit established? How long has it each account been established? And how long has it been since you’ve used the credit line? If you have a long history this will help your score.

Type of Credit: 10% impact. You lose points if you have nothing but credit cards. A mix of auto loans, credit cards, and a mortgage is ideal.

Inquiries: 10% impact. Every time you apply for credit it shows as an inquiry in the credit repository. Inquiries can lower your score because applying for more credit means you may be taking on new debt.

The credit report shows the number of inquiries that have been made on your credit history within the last twelve months. Each inquiry can cost as little as 2 points, and as many as 50 points against your score. If your credit score is high, the inquiry won’t affect you much at all. But if your credit score is lower, new credit is looked at as a big problem, and can bring your score down by as much as 50 points.

Also, if you’re about to buy a car or apply for a mortgage and have your credit run several times, make sure you do it all at once. It only counts as one inquiry if they’re all done in a 14 day period.

These scores are calculated by a computer that’s not taking any personal factors into consideration. When a credit report is generated, it’s simply a snapshot of your credit profile for that particular moment in time. Scores change, sometimes by large amounts in a short period of time. To make sure you don’t have a problem when you’re ready to buy, it’s important to have a loan officer review your credit and make sure you are on the right track.

I’ll have more tips on how to best use your credit in the next installment here at Illinois mortgage rates and news.

Here are the other installments in this series:

Part 1 – How our Credit System Works

Part 3 – 10 Ways to Raise Your Fico Scores and Improve Your Credit

Part 4 – Fixing Mistakes and Cleaning Your Credit Report

Illinois Mortgage Rates and News

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