Credit score. It’s a topic that’s widely discussed in the financial industry but it’s also one that’s hazy or even confusing to many people. Have you ever wondered just how well you know what affects your credit score? Whether you’re a first-time home buyer who’s unfamiliar with the rules of credit scoring or a weathered mortgage borrower who could use a refresher, read on to learn a thing or two about what affects your credit score.
Your credit score is your credit activity and history represented as a three-digit number. Credit scores can range from 300 to 850, and the higher your score, the better. Your credit score tells a lot about your financial history. Types of credit that can be reflected in your score include auto loans, home loans, student loans, credit card debt, etc. Your credit score paints a picture of how responsible you are at credit management and expresses your financial stability in a simple figure. It helps lenders determine your creditworthiness—your ability to pay back the money you borrow.
You may have heard your credit score being referred to as a FICO score: FICO (which stands for Fair, Isaac, and Company) uses predictive data analytics to generate the most accurate credit score. This helps lenders predict a consumer’s behavior. Using the FICO scoring model, Equifax, Experian, and TransUnion—the three major credit reporting agencies (CRAs)—generate your score based on your credit information. You may notice that your score is not exactly the same across all three CRAs—don’t worry, this is normal. Not all lenders and creditors report to all three CRAs, so although each score varies slightly, when combined, they represent your total credit score.
Credit score is very important when it comes to mortgage lending. We look at a borrower’s credit score to see if they have a track record of paying bills and repaying loans on time. Like we said, the higher your score, the better—but also, the higher your score, the more qualified you are to borrow again, and the more favorable terms you’re eligible for. Conversely, the lower your score, the less favorable the terms available to you may be. If your score’s too low, you may not qualify for a loan at all.
So, when applying for a mortgage—or any type of loan, for that matter—what affects your credit score? Let’s take a look at the five major factors to help you understand just what affects your credit score.
1. The length of your credit history. This aspect of your credit score shows how long you’ve been using credit and makes up 15% of your score. A long history of on-time payments is excellent—you don’t want to have a long history of late payments as this can negatively affect your credit score. Haven’t had credit for long? A short credit history isn’t a problem as long as it shows you’ve made payments on time.
2. The variety of credit. In determining what affects your credit score, lenders also look at how many different types of credit you’ve opened (sometimes called your credit mix). This accounts for 10% of your total credit score. Do you have auto loans, an existing mortgage, student loans, credit card balances, or another type of credit? How many of these do you have in total? Answers to these questions can affect your credit score. A variety of credit is good, but you don’t need one of every type of credit in order to have good credit.
3. Your payment history. Accounting for a whopping 35% of your credit score, payment history is a major component. It may not come as a surprise to you that a history of on-time payments is a good thing. It helps prove that you can be trusted to pay back the money you borrow. Have you ever received mail from your bank or credit card company stating that you’re eligible for a higher credit limit? That’s usually a good indication that you’re responsible with credit and you generally make payments on time.
As part of your payment history, your credit score can be affected by late payments. If you’ve paid late, how late? Have any unpaid bills gone to collections? If so, this might tell a lender that you don’t have plans to pay them back if you borrow from them. In addition, special cases such as bankruptcy or foreclosure can have adverse effects on your credit score and may even disqualify you for a mortgage. (Good thing Cardinal Financial offers a loan program to help borrowers with derogatory credit events qualify for a mortgage.)
4. Your remaining balance. When you think about what affects your credit score, probably one of the first things that comes to mind is how much you owe. That makes sense, because this makes up 30% of your credit score. It’s not just about how much you owe in total, but how much you owe on each line of credit. (How much you owe per type of credit matters too.) This factor also considers how much of your total available credit you’ve used. Remember, it’s best to demonstrate an ability to repay, so the lower your remaining balance, the better.
5. New credit you’ve taken on. The last 10% of your credit score is determined by the new credit you’ve taken on. This includes the types of new credit you’ve opened, how many lines of new credit you’ve opened, and if you’ve opened multiple lines around, roughly, the same time. Several new lines opened in a short amount of time may indicate that you’re about to take on a lot of debt, which may threaten your chances of loan approval.
Let’s say you’re planning to buy a home. You take out a credit card at Home Depot because the house you’ve got your eye on needs some renovation, you take out another credit card at Sears because you want to buy some big-ticket appliances, and you open up another line of credit with Art Van Furniture to finance a brand new bedroom set for this new home. When a lender sees this type of activity, they may think you’re getting ahead of yourself—you’re putting items on credit that you can’t afford before you even buy the house they’re intended for. If you just opened up a lot of new credit, a lender will see it and may think you don’t have the money to pay for all of these things—and their loan is one of them.
We hope this article helps you figure out what affects your credit score. This blog post is not intended to provide credit or financial advice. We recommend you consult legal counsel or a financial advisor when making decisions that may affect your credit.
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