Credit Scores-The Basics

Everything You Wanted to Know About Credit Scoring

Pacific Beach Real Estate, Mission Beach Real Estate, San Diego County Real Estate

A critical factor in determining the interest rate you receive when you apply for a home or auto loan or credit card is your credit score. Critical? Yes, and at the same time so universally misunderstood. As a result, I thought that an article explaining this most important financing aspect would be of interest to you.

What Is A Credit Score?

Your credit score is a number generated by a mathematical algorithm based on information in your credit report compared to information on tens of millions of other people. It is a "snapshot" of the risk a lender will assume in granting you credit at that specific point in time. It will change gradually as new information is added to your files. Lenders believe that the score is a highly accurate prediction of how likely you are to pay your bills. The higher the score, the better you look to lenders and people with the highest scores get the lowest interest rates. While computers analyze credit information to produce a score, it is the individual lender who decides what scores are acceptable for different loans or credit cards. Some lenders accept higher risk applicants while other lenders will charge a higher rate to compensate for the increased risk. Others merely use the score to help determine when to request additional information from the applicant.

What´s In A Credit Bureau Score?

Scores are based on 5 main categories of credit information. The relative importance of each are as follows with the category having the most weight listed first and the least, last:
  • Late payments, collections & bankruptcies
  • Amount of outstanding debt
  • Length of credit history
  • Types of credit in use
  • New applications for credit

Scoring Range

The scale runs from 300 to 850 with the vast majority of people having scores between 600 and 800. Generally, a "good" score is that number which matches the level of risk a lender is willing to accept for a particular loan or credit card. More specifically, however, a score of 720 or higher will usually get you the most favorable interest rates on a mortgage, according to data from Fair Isaac Corp., a California based company that developed the credit score. (Its own score is called the ell known FICO score.) Fair Isaac reports that the American public's credit scores break-out along these lines:

Credit Score

Percentage

499 and below  1 percent
500-549  5 percent
550-599 7 percent
600-649 11 percent
650-699 16 percent
700-749 20 percent
749-799 29 percent
800 and above 11 percent
Simply from a mortgage lending perspective, here is another - yet important - way to look at your credit rating:

Credit Score

Mortgage Borrower Rating

499 and below  VERY hard to obtain
500-524  "C-" to "D" Borrower
525-580 "B-" or "C" Borrower
581-620 "B" or "B-" Borrower
621-660 "B+" or "B" Borrower
661-680 "A-" Borrower
681-719 "A" Borrower
720+ "Golden" Borrower

Lender Risk Facts

If you have an 800+ credit score, you have a 1 in 1293 chance of defaulting on your loan. On the other hand, a 600 and below score yields a 1 in 9 chance. And, 50% of all mortgage lender defaults occur with borrowers who have a 620 and below credit score.

Steps For Improving Your Credit Rating

How Do I Find Out My Score?

Some lenders may tell you your score, however, a score in isolation does not provide much information. Scores are dynamic and lenders do use other factors, like application information, when making credit decisions. And, what´s an acceptable score can vary greatly from lender to lender depending on the type loan you are applying for. The first step is to find out what ALL of the top three credit bureaus, Equifax, Trans Union and Experian, are saying about you. It's likely that they're all slightly different. They are different because creditors don't have to report to all three credit bureaus. As a result, they typically report to the credit bureau to which they subscribe. And, make absolutely sure that you order your reports at least once a year especially before making a large purchase like a home.
Credit Bureau Phone Numbers and Addresses
  • Equifax P.O. Box 740241 Atlanta, GA 30374-0241 (800) 685-1111
  • Experian (formerly TRW) P.O. Box 2104 Allen, TX 75013-0949 (888) 397-3742
You can generally order a credit report from each bureau for around $9. Also, if you've been denied credit because of your report, you are entitled to a free copy from the reporting agency. The company you applied to must supply the credit bureau's name, address and telephone number and you have 60 days after receiving the denial notice to request your copy.

Examine Your Reports Carefully

You need to make absolutely sure that every bit of information in your report is correct. Unfortunately, nearly every consumer has an error on at least one credit report from one of the major credit bureaus and, they generate your report on information they receive from your creditors; they don't verify. Keeping your credit report a true reflection of you is, like it or not, your job. Get ready to clean and polish by carefully looking for everything from typing errors, outdated and incomplete information to inaccurate account histories. You'll want to make a thorough list of items you dispute and why. Be meticulous. If the negative information in your report is true, only time and improved habits can change it. Late payments and charged-off accounts remain on your report for seven years; bankruptcies for 10. Most creditors, however, look for a pattern of payment rather than focusing on one-time or rare occurrences. Thus, consistent on-time bill payments will improve any blemishes.

Double-D Strategy -- Dispute and Document

Remember, a bad report costs you money. So, it pays to be thorough! You can either complete the dispute form provided with your credit report or write a letter. Clearly identify each mistake and state why it's wrong. My recommendation is to send a photocopy of your credit report with the mistakes circled to the reporting credit bureau. Include copies of supporting documents. Document, document, document. Keep copies and records of all the forms, letters and documentation that you send to the credit bureaus. The credit bureau must investigate any relevant dispute and respond to you within 30 days of receiving your letter and any item that is not verified as accurate by a creditor should be removed. Unfortunately, sometimes it's necessary to contact your creditors to resolve mistakes. If there are items, which you are disputing, and you are in the process of applying for a loan, immediately notify your lender of the dispute, knowing that small errors may have little or no impact on your score. If there are significant errors that you can substantiate, the lender may disregard the score altogether. If the credit bureau makes any changes to your credit file, it will send you the results and a free, updated copy of your credit report. Once a negative item is removed from your report, the credit bureau cannot put it back on unless a creditor verifies its accuracy and completeness and sends you written notice.

What If You Are Turned Down For Credit

While lenders are not required to disclose your score, if you have been denied credit, the Equal Credit Opportunity Act requires that you be given the reason why within 30 days. Possible reasons a score is too low might include recent late payments or too much outstanding credit. You are also entitled to a free copy of your report and you should ask your lender how you can improve your score.

Applying For A Home Loan

I would like to cover two common issues which I hear quite often:
  1. Applying For New Credit: Many folks ask me if their score will drop when they apply for a home loan. The answer is "probably not much... if at all". If you apply to several lenders for a home loan within a short period of time (called "inquiries), these multiple requests will appear on your report. Looking for new credit can equate with higher risk, but most lenders are not affected by multiple inquiries. Typically, these are treated as a single inquiry and will have little impact on your score. However, it´s not a bad idea, if you are applying to multiple lenders, to get a copy of your report from the first lender you apply to and provide a copy to the others.
  2. Weak Credit? If you know that your credit may be a bit weak and you are about to begin your search for a home, I suggest that you contact a lender early-on in the process. By doing so, the lender can oftentimes assist you in clearing up credit issues within an approximate 45 day period so that you can either qualify for a loan program and/or obtain that lower interest rate you wanted.

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