Think about the most critical numbers in a person’s life: Cell numbers, social security numbers … some may be surprised to learn that their credit score number should also be on the list. That’s because it’s the most important number in the world when buying a house. But what defines a good credit score? Who can teach you how to increase your credit score? This is your definitive guide to credit scores and everything you need to know.
Livabl spoke with Anthony Gallop, a residential lending specialist at FrostBank in San Antonio, Texas, for more details.
What is a credit score?
“A credit score is a number that predicts your credit behavior,” Gallop said. “It helps lenders figure out how likely a borrower will be to repay a loan on time. Your credit score will determine your likelihood of securing a mortgage, car loan, credit card, or other products like lines of credit. They’ll also be used to decide your credit limit and the interest rate you’ll be given when it’s time to pay back the loan.”
Your credit score is generated by businesses using a mathematical formula known as a scoring model based on data from your credit report. But what’s a scoring model?
“Credit bureaus use stats from your credit history to create these scoring models,” Gallop said. “Different elements are assigned different levels of importance when figuring out your total score. For example, the amount of debt you’re currently carrying, the number of credit cards you have, how much of your credit you’re using, and the length of history you’ve had with banks are all considered.”
In short, if a customer is responsible with their credit, pays off the balance of their credit cards on time, and isn’t carrying a large amount of debt, they’ll have a higher credit score. However, various credit score models place different weights on different elements. That’s why other credit bureaus may have slightly different scores for the same borrower.
What’s a credit bureau?
“You’ve likely heard of FICO,” Gallop said. “That’s because they because their reliability is well known.”
FICO, formerly the Fair Issac Corporation, has been around since 1989. FICO has been revised multiple times to account for the changing factors that affect a person’s credit score. Today, there are at least 16 versions of the FICO model, and they are used by 90% of the country’s top lenders.
FICO 10 and FICO 10T, collectively known as the FICO Score 10 Suite, are FICO’s latest credit scoring models (formerly the Fair Isaac Corporation). According to the company, FICO 10 and FICO 10T are designed to outperform all previous versions of FICO scores in helping lenders evaluate credit risk.
With the aid of trended data, FICO 10T offers a new perspective on credit scoring. It examines how consumers have handled their financial accounts over the past 24 months, considering whether they carried a balance from month to month or combined their debts during that time.
Here’s the most significant difference between 10T and other credit scores: Traditional scores that don’t use trended data typically use the most recently reported month of data to drive specific components of the score, such as the most recently reported balance and credit limit on an account.
How credit scores break down
Based on your financial history, FICO credit scores are meant to help lenders, such as banks and credit card issuers, predict a borrower’s risk potential. Specifically, FICO scores take five major factors into account:
• Payment history (35%)
• Credit utilization (30%)
• Credit age (15%)
• Credit mix (10%)
• New credit (10%)
The VantageScore model
“Keep in mind that a borrower doesn’t have a single credit score,” Gallop said. “It doesn’t matter whether you’ve ever filed for bankruptcy, had your home foreclosed upon, or had a debt collector chase you down for payment; there’s going to be more than one number. Each credit score is based on the data used to create it. That means each score may differ depending on the scoring model, the type of loan, the data source, and even the day the score was generated.”
Another version of a borrower’s credit score can come from VantageScore. According to Debt.org, The VantageScore model was introduced in 2006 when the three major credit reporting bureaus — Experian, Equifax, and TransUnion – decided to offer FICO some competition in the credit score business.
To calculate its score, the VantageScore model looks at data similar to FICO’s— paying on time, keeping credit card balances low, and avoiding new credit obligations, bank accounts, and other assets. VantageScore breaks it down this way:
• Payment history (40%)
• Length and type of credit (21%)
• Credit utilization (20%)
• Total balances (11%)
• Recent behavior (5%)
• Available credit (3%)
What’s a good credit score?
FICO and VantageScores’ credit numbers range between 300 and 850. A good score at FICO begins at 670, whereas VantageScores’ good rating starts at 661. VantageScores’ “excellent” range is slightly broader, containing scores between 780 and 850. By comparison, a borrower must have a credit score of between 800 and 850 to qualify for the same rating with FICO.
For a conventional mortgage, you’ll need a credit score of at least 620. But other types of loans are available with lower credit minimum credit scores if you qualify.
FHA Loan | Credit Score: 580
The Federal Housing Administration created FHA mortgages in the 1930s to make homeownership attainable, and they were the first type of mortgage loan available to borrowers. Due to its flexible down payment requirements and the fact that the FHA doesn’t base your interest rate on your credit score, FHA loans are more inclusive than other loan options.
VA Loan | Credit Score: 580
The Department of Veterans Affairs backs VA loans. Veterans and active-duty military personnel can obtain affordable mortgages through VA loans.
Mortgage lenders offer VA loans at lower interest rates because the VA insures its loans against losses. Historically, VA mortgage rates have frequently been the lowest of all readily available mortgage loans. In addition, there is no down payment needed with VA loans.
How to check your credit score
Figuring out your credit score is no longer a mystery. Potential borrowers are constantly barraged with ads on television and podcasts for sites that let them check their credit scores for free.
Past concerns of damaging one’s credit score by inquiring are no longer a problem. A personal search of a credit score is considered a “soft pull” of data information. Soft pulls simply look for information, whereas a “hard pull” is done whenever a credit application is made. Hard pulls can harm your credit score and will stay on your record for a few months, so a borrower needs to be strategic about how often they apply for credit. If they are in the market for a new home and require a mortgage, it’s best not to apply for other credit products directly prior to or during the mortgage application process.
If borrowers are looking for free sites to check their credit scores, they can check out Credit Karma, Credit Sesame, and Credit.com. In addition, many credit card companies will also offer free credit score updates to their users.
How to increase your credit score
Here are five tips to improve a credit score:
• Get that credit score number as quickly as possible. Borrowers need to know where they stand and how much improvement must be made before applying for a mortgage. Also: Contact the credit bureaus for a free copy of the credit report. Review it for accuracy and if there are any errors, report them back to the bureau immediately. An unnoticed mistake on a credit report can wreak havoc on a credit score.
• If a borrower has any outstanding collection items on their credit report, they must be paid off as soon as possible. Collection items take seven years to be removed from a credit report, so it’s critical to resolve them quickly.
• Make every payment on time. Ultimately, a borrower wants to pay off the balance of bills every month, but if that’s not possible, make those minimum payments on time, every time. Payment needs to be received and processed before the bill’s due date to benefit a credit score, so put reminders in a calendar to make those payments around five business days in advance.
• Reducing the balances on credit cards will bump up a credit score. Tackle the ones with the highest interest rates first. The higher a borrower sits at their credit limit, the more damage will be done to their credit score. An excellent short-term goal is to decrease account balances owing to below 50% of available credit limits.
• Create a budget. Build a strategy to manage finances and get the most out of each paycheck. This will make it easier to pay off debt more quickly, make prompt payments for expenses, and increase savings.
Understanding a credit score doesn’t have to be a mystery. Once a borrower knows their numbers, it will give them a clear idea of where they stand with lenders and how easy (or difficult) it may be to secure a mortgage.
Make use of free online tools and don’t hesitate to ask the lender questions about potential options. Budget, strategize, and organize. That’s the fastest way to a healthy credit score.