When it comes to buying a home or refinancing your mortgage, one of the first things your lender will need is a credit report. Like most people, you probably have a general sense of whether or not you have good credit. If you routinely pay your bills late, or don’t pay them at all; you can expect your credit score to be low. However, if you’ve never missed a payment on a loan or any other bill, yet your credit score is still less than outstanding (meaning anything less than 750) you may not be sure why.
The three major credit reporting companies, Experian, TransUnion and Equifax all use similar basic criteria for determining credit. Here’s a look at the five factors that determine your credit score.
Your payment history is incredibly important. In fact, your personal payment history accounts for as much as 35% of your overall credit score. Serious delinquencies in payments including foreclosures, short sales, repossessions and bankruptcies all drive your credit score down. Late payments will also have a negative impact, though their impact may not be as severe. Being 30 days late is always preferable to being 60 days late, and your more recent delinquencies will hurt your credit more than delinquencies from a few years ago.
If you’ve always been current with your payments, but found yourself making a late payment once or twice -perhaps due to being out of town or as the result of a personal emergency- pay the balance immediately. Once you’ve done so; call the creditor. They may be willing to delete the delinquency if your history shows that it was just a fluke.
Credit reporting companies will also base your credit score largely on your balances relative to your credit limits. Your existing balances will account for roughly 30% of your score. For example, if you only have one credit card with a limit of $10K, and you currently owe $9,500, the debt to availability ratio will drive down your score. However, if you have available credit on multiple cards of $40K, but only owe $9,500, your debt to availability is viewed more favorably by the reporting companies.
The longer your credit history, the better. Credit reporting companies like to see that you’ve borrowed and paid back your loans consistently over time. It establishes a record of reliability that will drive your credit score up. To that end, if you have had a credit card for 10 years, but rarely use it; it’s still a good idea to keep the account open. Longevity of credit can count towards as much as 15% of your credit score, so it’s wise to maintain open lines of credit, even if the interest rates aren’t great.
Type of Credit
The type of credit you have on your report will account for 10% of your total credit score. Not all types of credit and/or loans are weighted equally. For example, department store or electronics store credit cards are generally provided through a finance company rather than your credit union or local bank. Borrowing from established financial institutions and banks is viewed more favorably than borrowing from finance companies.
Multiple inquiries into your credit will lower your credit. However, when you are shopping for a home loan or an auto loan, credit bureaus will understand that multiple inquiries within 10 days- 2 weeks may be necessary, and as such will only count the inquiries as a single “hit” to your credit. However, ongoing inquiries will result in negative “hits” on your credit, lowering your score. It’s not a good idea to keep opening lines of credit year round.
No matter what your credit score is currently; there are always ways to improve it. In a subsequent column, we’ll take a look at ways to boost your credit score, so that when you are ready to buy your dream home or refinance; you can rest comfortably knowing that your credit is in great shape.
Fred Arnold is a Certified Mortgage Consultant, Chairman of the SCV Chamber of Commerce and mortgage professional at American Family Funding in Southern California. Fred hosts the radio show The SCV Chamber Business Hour on AM 1220 KHTS, as well as the televised program Out of The Rough on SCVTV.com, channel 20.
He can be reached at Fred@fredarnold.com or via phone at 661-505-4300