The Basics of Credit Scoring
Today, we are going to be centering on the basics of an increasingly important portion of a buyer's mortgage application - the credit score.
First, the 3 major national credit bureaus are: Experian (XP), Transunion (TU), and Equifax (EF). But better terms to describe their function are:
- Repository -they are huge "holders" of data; information about you and millions of other people.
- Credit Reporting Agency (CRA) these repositories get their data when creditors and courthouses "report" to them; and when you pull someone's credit report, they in turn "report" that data to the entity that requested the information.
Credit Scores (in general)
What is a Credit Score? It's a number that, at a glance, helps lenders determine how likely you are to make your proposed payments on time.
How is it generated? A score is only created when you pull someone's credit file, and all the data retrieved is fed through a complex mathematical formula. As a person's data at the repositories changes, their score would change also - positively or negatively.
Why are scores different? Fair Isaac Corporation (FICO) created the mathematical formulas that generate the score, BUT -
There are different score formulas depending on what you are applying for - a mortgage, credit card, auto loan, insurance, or even if you are not applying for anything at all and get a "consumer" score directly from one of many websites that advertise "scores" these days.
Fair Isaac sold their original formulas to XP, TU, and EF, which in turn, slightly altered them based on their own studies and analysis.
The 3 bureaus typically don't have the exact same data on a consumer. So, if the data is different or has changed, the scores will also be different.
The score range is 300-850.
The FICO score on your mortgage credit report
What makes up the score? (The info below is from www.myfico.com).
1. 35% of the score is based on Payment History
a. Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)
b. Presence of adverse public records (bankruptcy, foreclosure, judgments, suits, liens, wage attachments, etc.) collection items, and/or delinquency (past due items).
c. Severity of delinquency (how long past due).
d. Amount past due on delinquent accounts or collection items.
e. Time since (recentness of) past due items (delinquency), adverse public records (if any).
f. Number of past due items on file.
g. Number of accounts paid as agreed
2. 30% of the score is based on the Amounts Owed
a. Amount owing on accounts.
b. Amount owing on specific types of accounts.
c. Lack of a specific type of balance, in some cases.
d. Number of accounts with balances.
e. Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts), often referred to a Percentage of Usage.
f. Proportion of installment loan amounts still owing (proportion of balance to original loan amount on certain types of installment loans).
3. 15% of the score is based on the Length of Credit History
a. Time since accounts opened.
b. Time since accounts opened, by specific type of account.
c. Time since account activity.
4. 10% of the score is based New Credit and Inquiries
a. Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account.
b. Number of recent credit inquiries.
c. Time since recent account opening(s), by type of account.
d. Time since credit inquiry(s).
e. Re-establishment of positive credit history following past payment problems.
5. 10% of the score is based on the Types of Credit Used
a. Number of (presence, prevalence, and recent information on) various types of accounts (credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc.).
Special Note About Inquiries
This is always a hot topic because borrowers think they will hurt their score because their credit report is pulled. But as explained above, New Credit only accounts for 10% of a person's score, and of that, inquiries is only a part. Also, keep in mind what an inquiry represents - application for additional credit. If your credit report and score shows that you are a responsible borrower, then applying for more credit will have a minimal affect on your score. But if you appear to be an irresponsible borrower, then the inquiry may drop your score a few points, or several points.
Note what Fair Isaac itself says about inquiries at www.myfico.com:
For many people, one additional credit inquiry (voluntary and initiated by an application for credit) may not affect their FICO score at all. For most people, a credit inquiry will only decrease their FICO score by a few points.?
Looking for a mortgage or an auto loan may cause multiple lenders to request your credit report, even though you're only looking for one loan. To compensate for this, the score ignores all mortgage and auto inquiries made in the 30 days prior to scoring. So if you find a loan within 30 days, the inquiries won't affect your score while you're rate shopping.