12.05.06
How Important is My Credit Score?
By Nancy Winter, Mortgage Banker
The answer to most of the questions I get concerning mortgages is “it depends”, but the answer to “How important is my credit score?” is - that it is EXTREMELY, HIGHLY, COMPLETELY, POWERFULLY, TERRIBLY, and any other synonym you can find that means UNBELIEVABLY important! I cannot convey the importance of the credit score in determining whether or not you qualify for a mortgage, and what the rate on that mortgage will be.
So what is a credit score? A credit score is an actual number. The number is determined based on a computer formula that is used by the credit reporting agencies. It is a snap shot of your current credit status along with a history of your past credit.
There a five major components for determining your credit score.
1. Payment history. This accounts for 35% of the total score. Each account shows the number of months the specific account has been reviewed. It also shows how many times the minimum monthly payment has been late 30, 60, or 90 days. I cannot stress the importance of paying the minimum required payment on time! Some times borrowers say that they didn’t make a minimum monthly payment for whatever reason, but they paid it off the next month or so. That is not good. You do not improve your score by paying off a balance, but you do increase your score by always paying at least the minimum on time.
2. Amounts owed. This accounts for 30% of the total score. Each account shows the High Credit limit and the current balance. If a borrower has an account with a high credit limit of $5,000 and the current balance is $2,500, the available credit is 50%. On the summary portion of the credit report is a total of all accounts, with the percentage of total credit available. The higher the percentage of unused credit the better the score. Someone who has available credit of 90% vs. someone who has available credit of 10% is going to have a higher score. I have found that it is good to have more than one credit card with fairly high credit limits. This doesn’t mean you have to use them all the time and carry balances, but just have the credit available. The most negative affect is to have one or several credit cards that are maxed out or close to the maximum.
3. Length of history. This accounts for 15% of the total score. Each account shows the date that the account was opened. I have one account that has been open since 1968 (before I graduated from high school). Back then it was a Dayton’s account, and as Dayton’s has been sold the account has rolled over to the new owner, but it still reflects the open date as 1968. I haven’t used the account in years, but keep it open just because of the length. Of course, young borrowers cannot increase the amount of time that their accounts have been open. If you are considering closing any accounts, I strongly encourage you to take into consideration the length of time each account has been open. Just because you have an open account does not mean you have to use it. In recent years I have seen borrowers transfer balances to introductory low interest rate cards. This can help the amount of interest you are paying, but may affect your credit score in the length that your accounts have been open. The best credit scorers pay their balances in full each month and do not get into the credit card trap.
4. Types of credit in use. This accounts for 10% of the total score. The credit report classifies credit as to credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. This tends to be rather variable in importance. This is where my standard “it depends” answer comes in. The computer seems to like a mix of accounts, but it depends on the number of accounts and other factors in the report. (It feels good to have an “it depends.”)
5. New credit inquiries. This accounts for 10% of the total score. The credit report shows what are termed inquiries into your credit. When you knowingly or unknowingly authorize someone to look at your credit report, it shows up on your credit report. The computer believes that multiple credit requests in a short amount of time represent greater credit risk and thereby lowers your overall credit score.
Now that you know what factors go into calculating your credit score how do you know what the number means, and how does it affect your mortgage rate? Credit scores range from 350 – 850. The breakdown for the general population is roughly the following:
20% Below 620
20% 620 - 689
20% 690 - 739
20% 740 – 780
20% Above 780
Each type of mortgage has credit score requirements. For example, to obtain a conforming 30-year fixed mortgage, the borrower must have a minimum credit score of 620. The credit report will give three credit scores, one from each of the three agencies. The computer will select the middle score as the representative score. If more than one borrower is considered, the computer will select the LOWER middle score. If the mortgage type has a minimum credit score, that is the minimum. If the minimum is 620 and the borrower’s score is 619, the borrower will not qualify for that particular mortgage. Some mortgages have minimum credit scores of 700. Low credit scores do not necessarily mean that a borrower will not qualify for a mortgage; it may be that they qualify, but that the rate will be higher than what it would be for a borrower with a higher credit score.
There is so much more to say about how credit scores affect your ability to borrow. What I hope you have learned for now are the factors that go into your credit score and the importance of having a high score. Remember, only you can control your credit score.