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FICO Scores - A Brief Explanation

When you apply for a mortgage loan, you expect your lender to pull a credit report and look at whether you've made your payments on time. What you may not expect is that they seem to be more interested in your "FICO" score.

What's a FICO score?

FICO stands for Fair Isaac & Company and is the name for the most well known credit scoring system, used by Experian. The credit bureau's computer evaluates a complete credit profile and assigns a score, which is used to estimate credit worthiness. Each of the three bureaus (Experian, Trans Union, Equifax) employs its own scoring system, so a given person will usually have 3 separate scores. Scores can range anywhere between the high 300's and the low 800's; but someone with a higher score will be viewed as a better risk than someone with a lower score.

How is My Score Determined?

The FICO model has 5 main elements:

1. Past payment history (about 35% of score): The fewer the late payments the better. Recent late payments will have a much greater impact than a very old Bankruptcy with perfect credit since MYTH: paying off cards with recent late payments will fix things. Payoffs do not affect payment history.
   
   
2. Credit use (about 30% of score): Low balances across several cards is better than the same balance concentrated on a few cards used closer to maximums. Too many cards can bring down the score, but closing accounts can often do more harm than good if the entire profile is not considered. BE CAREFUL WHEN CLOSING ACCOUNTS!
   
   
3. Length of credit history (15% of score): The longer accounts have been open the better for the score. Opening new accounts and closing seasoned accounts can bring down a score a great deal.
   
   
4. Types of credit used (10% of score): Finance company accounts score lower than bank or department store accounts.
   
   
5. Inquiries (10% of score): Multiple inquiries can be a risk if several cards are applied for or other accounts are close to maxed out. Multiple mortgage or car inquiries within a 14 day period are counted as one inquiry.

Your Credit Report and FICO Score

Thus, each time your credit report is pulled, it is run through a computer program with a built-in scorecard; points are awarded or deducted based on the above elements. Things such as how long you have had credit cards, whether you make your payments on time, if your credit balances are near maximum, and assorted other variables will affect your score. Other variables that can negatively affect your FICO score are:

• Delinquencies
• Too many accounts opened within the last twelve months
• Short credit history
• Balances on revolving credit are near the maximum limits
• Public records, such as tax liens, judgments, or bankruptcies
• No recent credit card balances
• Too many recent credit inquiries
• Too few revolving accounts
• Too many revolving accounts

Why Your FICO Score is Important

The reason the FICO score has become so important is that at one point Lenders wanted to determine if there was any relationship between these credit scores and whether borrowers made their payments on time; so they did a study. The study showed that borrowers with scores above 680 almost always made their payments on time. Borrowers with scores below 600 seemed fairly certain to develop problems.

As a result, credit scoring became a more important factor in approving mortgage loans. Credit scores also made it easier to develop artificial intelligence computer programs that could make a "yes" decision for loans that should obviously be approved. Nowadays, a computer and not a person may have actually approved your mortgage. More importantly though, is that if your score is below 600, most mortgage lenders will not even consider you for a loan.

How Can I Raise My Score?

Your score can only be changed by the way that item is reported directly to the credit bureaus (Experian, TU, Equifax). Written confirmation from the creditor is required. It is best to make these corrections before you try to purchase a home, because you can never be sure the exact impact a change will have on your score.

What Does This Mean to Me?

You should have your credit reviewed BEFORE you look for a home, and work with a PROFESSIONAL loan officer to make sure your loan is based on the most accurate information.

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