Your FICO Score: What you can do about it
FICO is an acronym for Fair Isaac & Co. They are the designer of the credit scoring system used by the credit bureau Experian. FICO has become the generic term for all credit scoring systems even though the credit bureau Equifax uses a score developed by Beacon and the credit bureau Transunion uses a score developed by Empirica. What is the same is that none of these companies will reveal what their formula is. However, we do know that certain actions will raise or lower the score. We’ll go into that in a moment.
First off, you may be wondering why credit scores were invented and what they are used for. A credit scores attempt to measure a borrower’s willingness to pay a mortgage. It is a statistical summary of all the information contained in a consumer’s credit file. The higher the credit score, the less likely the borrower is to default. This is important because the willingness of the borrower to pay back the loan is one of the three parts an underwriter looks at when determining if they are going to give a consumer a loan.
Many lenders use credit score levels to qualify consumers for certain loan plans, higher loan amounts, lower rates and/or reduced fees. The typical score levels for preferred loan plans vary among lenders, but generally are similar to the following.
720 and above
660 is the minimum score for a Fannie Mae or Freddie Mac conventional load. 680 is a credit score cut-off level for many conventional lenders.
The FICO score make up
The following factors contribute to the overall score for the FICO system:
Payments history: 35%
Amounts owed: 30%
Length of credit history: 15%
New Credit: 10%
Types of credit: 10%
Items that affect credit scores include:
Public records (collections, judgments, foreclosures, bankruptcies)
Late payment (how recent and how frequent)
Multiple inquiries for auto or real estate loans made within a 14-day period are considered as only one inquiry for each category.
Credit inquiries (stay on credit reports 24 months, but the score only considers the most recent 12 months)
For instance: A recent 60-day late lowers a score more than a 90-day late from 5 years ago. Multiple 30-day lates within the past few months lowers a credit score more than a 60-day late last year.
Improving credit scores
Closing out zero balance credit cards will NOT improve credit scores.
Paying down credit card balances for all accounts, for example paying down one account by 30% may improve scores. However, using the same amount of money and paying off several accounts and keeping the remaining with high balances can lower scores!
Using credit cards consistently, but prudently, and maintaining low balances in relationship to credit limits, may improve scores. On the other hand, having open credit card accounts with zero balances and not using them may neither improve nor lower scores.
You want at least 4 credit lines maintained in the last two years. If not, the consumer will want to increase their credit responsibly and gradually. This can increase scores.
How are the 3 scores used?
Theoretically, scores may range from 300 to 900. Lenders offer certain loan plans to borrowers based on meeting the minimum requires score for a given plan. Since lenders obtain credit scores from all three credit bureaus, they usually will use the following guidelines for establishing the qualifying score.
The “middle” score of all three bureaus will be used if all three bureaus provide scores.
If only two bureaus report scores, then the lower score will be used.
If more than one borrower is applying, the lower score of the two borrowers will be used.
If one of the two borrowers’ scores does not meet the minimum acceptable scores, than neither is qualified.
Remember: Bad credit cannot be repaired unless it is due to an error in the report. Time is the only thing that will repair bad credit. As a bad item or incident “falls off” the report and no new bad items come on, then the credit score “will repair.” The best way to have good credit is to always pay at least the minimum payment on time and not have too much or too little credit.
Thanks to the California Association of Realtors, Residential Real Estate Finance GRI Course 109 for much of the background for this article.