What is a Credit Score?

The Federal Trade Commission (FTC) defines a credit score as a “number that represents a rating of how likely you are to repay a loan and make the payments on time.” And people actually have multiple credit scores.

In general, a credit score is a three-digit number, usually ranging between 300 and 850, that represents the likelihood that you’ll pay your debts and pay them on time. You will be better positioned for approval with a higher score, and the higher the score the better the rates and terms. 

Credit bureaus calculate scores using credit report information, although they can use different algorithms to come up with results. 
 

Credit Score Factors

Using FICO® as an example of a credit score often used by lenders, there are five factors that go into calculations.  Understanding the factors and how they apply to the calculation of your score helps you to prepare for financial success!
 

1. Payment history: 35%

This is the most important factor because past actions are a good indicator of future ones—and lenders will want to know if you’ve paid your bills on time. Bills taken into account include mortgages, installment loans (car, personal, student, and so forth), credit cards, and more. 

Overdue payments and the number of accounts in arrears (behind on payments owed) negatively impact scores. The amount of delinquent dollars and how overdue they are also have negative impacts. Bankruptcies and foreclosures can have an especially significant impact on this portion of a credit score calculation. Bankruptcies typically stay on your credit report for 7 to 10 years.
 

2. Amount owed: 30%

At a high level, this refers to how much debt you have overall. What’s more important, though, is your credit utilization percentage. To calculate yours, first add up all of your credit balances (credit cards, installment loans, etc). Then, divide that amount by the sum of your credit limits. Ideally, you will be using less than 30% of what’s available to you. A low utilization rate can signal to lenders that you can manage the credit you’re given. On the other hand, maxing out credit cards can raise a red flag.

Note that, even if you pay off credit card balances in full each month, the balance listed on a credit card may not be zero if the lender reports the balance before you’ve made your payment. If you are getting ready to make a major financial move, knowing the reporting dates of each account will help you greatly.  This will determine the best time to run a credit report and maximize on all of your hard work.  Having a utilization rate of 10% or less is ideal.
 

3. Length of credit history: 15%

Your FICO Score will factor in how long you’ve had credit accounts, the average age of them, plus the age of the oldest account and the newest. The algorithm also considers how long it’s been since you’ve used your accounts. Overall, having a longer credit history is a plus, but it isn’t an absolute requirement to have a good credit score.

This leads to a commonly asked question: Once you pay off a credit card balance, should you close it if you don’t want to build up a balance again? Each situation is unique, but it can make sense to consider what effect this could have on your credit history’s length—and, therefore, your credit score.  Not closing an account after you have paid it off will also add to your available credit, this can benefit you greatly as it brings your utilization percentage down.
 

4. Credit mix: 10%

This term refers to the types of credit you have. For example, someone could have a mortgage, installment loans (perhaps a car loan and/or a student loan), and credit card accounts. Although you don’t need to have each of these kinds of credit, having a mixture can show lenders that you can successfully manage more than one type. 

An installment loan typically comes with a fixed monthly payment that you make over a predetermined term until the balance is paid off in full, like a mortgage or a car loan. Meanwhile, a revolving account comes with a credit limit that you can flexibly use, pay down, and then use again. 
 

5. New credit: 10%

If you apply for too many credit accounts in a short period of time, this can hurt your scores—especially if you haven’t yet built up a solid credit history. When there are too many new accounts, this automatically lowers the average age of your credit accounts, negatively impacting FICO scores. Plus, the act of applying too often can lower a credit score, even if the applications aren’t approved.
 
There’s a difference, though, between a hard inquiry (hard credit check/hard pull) and a soft one. With a hard pull, a financial institution checks your credit to make a lending decision. Although just one hard inquiry may not impact your credit scores at all, having too many could temporarily lower them by a few points. These inquiries show up on your credit report for two years, and lenders could interpret multiple inquiries as a sign that you’re short of cash and in need of numerous sources of credit.
 
In contrast, a soft inquiry/pull/credit check is done to investigate a situation, perhaps to see which credit cards a borrower might qualify for. Soft pulls don’t affect your credit scores and may not even be listed in credit reports. When you check your own scores, this is considered a soft credit check.
 
So, these five factors—payment history, amount of debt/credit utilization, credit history length, a mix of credit types, and new credit applications—are used to determine your FICO score, one that financial institutions often use when making lender decisions. Other credit bureaus (with Experian and TransUnion being the other two) may use slightly different calculations for their scores.

What is a Good Credit Score?

Continuing with FICO as our example, here is how credit scores are categorized:
 

Lenders can each have their own guidelines and minimum scores that they require for loan approvals. As a literal answer, though, a lender using FICO for credit checking would consider a “good” score to be 670-739 with higher scores above that to be “very good” or “exceptional.”

I would love to help you explore your credit rating and fulfill your mortgage needs! I have helped my clients get into better rates and achieving their ultimate life goals. Please give me a call today at 848.525.7449 and I will make your mortgage experience FLamazing! You can also fill out an application at: https://www.blink.mortgage/app/signup/p/ersnationwideinct/marisamcadorey

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