Five Components of Credit Scoring

In order of importance:

Payment History. Perhaps the most important factor. Repayment of debts on time and in full is a big plus. Late payments, judgements, charge-offs, etc. as you can imagine can significantly reduce one's score. Delinquencies within the most recent 2 year period affect score more than those that are much older.

Outstanding Credit Balances. Almost as important as payment history. The higher the balance as a percentage of the available limit, the lower the score. Better to keep outstanding credit (particularly revolving debt, such as credit cards) balances below 30% of available.

Length of Credit History. As it pertains to when credit for a particular debt was established. Generally, the older the debt (i.e. a car loan, mortgage, etc.), the better. Thus, a borrower who has a lengthy history of satisfactory debt repayment, is a lower risk and therefore have a higher score than one who recently opens credit accounts for the first time.

Type of Credit Used. A variety of different types of debt (installment and revolving - mortgage, car loan and credit cards) is better than a concentration of a particular type of debt obligation (revolving only - credit cards).

Credit Inquiries. The number of times a credit report is "pulled" for a consumer within the preceding 6 month period can reduce the credit score. More than 10 inquires in a 6 month period should have no further impact on a borrower's credit score. Each inquiry, can reduce a consumer's credit score anywhere from 2 to 50 points.

When it comes time to buying a home, mortgage applicants would be well advised not to go out on a shopping spree for furniture or any other big ticket items. Borrowers should always exercise extreme caution in continuing to manage their credit practices throughout the loan process.

How Does Credit Affect My Mortgage Rate?

Good Credit Equals Lower Mortgage Loan Rates.

Over the years, I am often asked whether or not credit impacts the interest rate one can obtain from a mortgage lender. I always give a resounding yes. In fact, good credit not only means that you "should" get lower rates on most types (mortgage, car, personal) of loans, but it also opens the barn doors to all types of credit possibilities.

Why exactly is this the case? Back in the day (we're talking the 1960s) the Fair Isaac Corporation developed a scoring system which lenders could rely upon to determine the probability of timely repayment of loans. Before this, lenders had not much more than a man's (or woman's) word, upon which to rely.

A few decades later, how things have changed. Credit scoring is a lender's first line of defense. Although loan decisions are not made soley on a consumer's credit score (in theory), it can definitely put a damper on a consumer's ability to borrow money, as well as the cost of borrowing money. FICO scores can range from 350 to 850, the higher the score, the better.
I have recent studies indicating that only 1 out of 1300 people in the U.S. have a credit score above 800, whereas 1 out of 8 prospective home buyers have a credit score between 500 to 600.

Take a look at the chart below which illustrates how credit score can affect the interest rate.

For more information, contact a qualified lender.