What You Need to Know About Credit Score

Home buyers who are seeking a mortgage should deeply understand what a credit score is.  What is a credit score?  Credit Score is a three-digit number that is used to predict how you will pay your bills. The creditor or lender uses the credit score on whether to grant or disapprove your loan application.   It also determines the interest rate that a lender or creditor offers.  The score ranges from 300-850 and is calculated using your credit history information from your credit report. Past history has shown that borrowers with higher credit scores are less likely to default on a loan.

There are several different versions of computing for your credit score, the most commonly used version is the FICO score developed by Fair Isaac Company.

There are 3 main credit bureaus, organizations that track credit histories and related information of individuals, namely Experian, Equifax and TransUnion.

Here's an approximate breakdown of how the credit score is determined:

Payment history includes:

-    Number of accounts paid, negative collections.
-    Delinquent accounts - total number of past due items, how long it's been past due, and how long it's been since you had a past due payment.

Outstanding Debt Information includes:

-       How much you owe on accounts and the types of accounts with balances.
-       How much of your revolving credit lines you've used -- looking for indications you are over-extended.
-       Amounts you owe on installment loan accounts vs their original balances - to make sure you are paying them constantly.
-       Number of zero balance accounts.

Length of Credit History:

-      Total length of time tracked by your credit report.
-      Length of time since accounts were opened.
-      Time that's passed since the last activity.
-      The longer your (good) history, the better your scores.

New Credit

-    Number of accounts you've recently opened and the proportion of new accounts to total accounts.

-    Number of recent credit inquiries. There will be a negative impact if there were numerous inquiries on your credit.
-    The time that's passed since recent inquires or newly-opened accounts.
-    If you've re-established a positive credit history after encountering payment problems.
-    In general, they want to make sure that you are not attempting to open numerous new accounts.

Mix of credit

-      Total number of accounts and types of accounts (installment, revolving, mortgage, etc.)
-      A mixture of account types usually generates better scores than reports with only numerous revolving accounts or credit cards.

How to Improve your Credit Score:

 
1. Pay your bills on time! Punctual payments are most effective way to improve your score.
2. If you are planning on applying for a mortgage, don't open new credit card accounts.
3. Maintain at most 25% credit on your credit card.
4. Do not allow inquiry on your credit report unless you absolutely have to.  In general, the more inquiries, the lower your score.  However, if you are shopping for a loan, make sure multiple inquiries occur within a few weeks, so that they can count as one inquiry on your score.
5. Review your credit report and correct any errors you find. One study concluded that as much as a quarter of reports list wrong information that hurt an individual's score. Correcting the mistakes can improve a score dramatically.
6. Keep old credit accounts, even if you're not using them. Creditors look at the debt-to-credit limit ratio and the average age of your accounts.