While we don’t know the exact formula and algorithms used to calculate the credit score, we do have an idea of how the score is determined. It is is all based on how you have used or abused your credit in the past. Lenders use your past history to determine credit payment patterns that you have developed with regard to payment to creditors. They are looking to see if you pay your creditors on time or if you are prone to not paying at all. They want to know if you have filed a bankruptcy lately and, in fact how many bankruptcies you have filed throughout the years.
Fraud and Embezzlement a Critical Issue for Employers
The Association of Certified Fraud Examiners (ACFE) estimates that 5% of revenue is lost to fraud and embezzlement every year. Applied to the U.S. GDP, this amounts to $730 billion every year!
Clean Up Your Act!
I once had a home buyer client who had filed three bankruptcies in her lifetime, which is quite a feat when you consider the bankruptcy laws only allow people to file bankruptcies every seven years. When the lender saw the number of bankruptcies, they denied giving her a loan. But, this story had a good ending. With counseling, the client cleaned up her act and later was able to purchase a home with acceptable terms after her bankruptcies no longer showed on her credit report.
Landlords use your credit history to see if you have ever had an eviction. Employers use your credit history report to gain a snapshot of your payment habits; they look to see if you are in debt and use this information to determine whether or not you are a high risk for embezzlement.
Because so many organizations use your credit history report to determine whether or not they will work with you, it is important to pay attention to your credit score.
Your score is determined by the following calculations.
35% is based on your past credit history
35% of your credit score is based on your past payment history; Lenders look at how you paid your bills in the past. They look at whether you “Paid As Agreed” and how many times you were 30, 60, 90, and 120+ days late making your payments.
30% is based on your current level of indebtedness
30% of your credit score is based on your current level of indebtedness, in other words, whether or not you overspend on the credit that you already have. It’s best not to “max” out your credit cards all the time. Let me give you an example. Let’s say you have a credit card with a $5,000 limit. That’s fine, and if you spend $5,000 each month and pay it down to zero every month that’s fine too. However, if you take that credit card to the max and only pay down, let’s say, $2,000 or you always have a high balance on it, then that will weigh heavily on your score and will bring it down considerably.
15% is based on the longevity of your debt
15% of your score is based on the time your credit has been in use. And, listen, the longer you have had credit, the better because the formula factors in longevity as a positive.
15% is based on the types of credit available to you
15% of your score is determined by the types of credit you have available. Ideally, you want to own various types of credit. Such as, two or three credit cards, an installment debt, like a carpayment or furniture payment, and a mortgage. This combination of credit types will help you increase your score. And, remember, we’re not looking for high balances; we’re looking for low balances maintained over a long period of time.
5% is based on your pursuit of new credit
5% of your credit score is determined by your pursuit of new credit. Certainly, 5% is not a big number, but pay attention to this – every time you allow someone to run your credit report, it matters. Granted, it doesn’t bring your score down dramatically, but 1 point can make the difference between getting a loan and not getting a loan.
The Range Lenders use to Determine Low, high, and good Credit Scores
|750+||excellent||the best rates and terms|
|700-759||above average||better rates|
|660-699||good||decent rates and terms|
|620-659||average||higher rates and less favorable terms|
|580-619||poor||low chance of getting a loan|
|Below 579||very poor||usually no loan approval|
Source: Credit Score Scale
Credit Score Scale
- Credit Score Scale 2012
Read more about credit score scales from different years and how the scales relate to you and your credit score.
Credit Score Ratings Change With the Economy
Economic hardship is relative to the lender and varies from time to time. During the time period beginning in the year 2008; the first sign of an economic down turn, lenders began to place hefty interest rates and unfavorable terms on loans financed for the purchase of homes. Prior to 2008, a “good” interest rate was any rate above 650.
What Is a Good Credit Score Range to Get a Home Loan?
Generally, lenders want to see scores in the 700 to 800 range, especially in times of economic hardship. Lenders know there is more of a risk in an economy when unemployment is high. They know there is a likelihood of the borrower being out of a job and forced into a position of becoming negligent with timely loan payments. So, in times of hardship, a credit score between 700 and 800 is considered good. When you have a good credit score, you can expect a better chance of receiving favorable interest rates and terms for your home loan.
Typically, if you have a credit score of 640 and below, you would have a difficult time obtaining a loan, and if you are approved for a loan, it would be what is called a subprime loan. Subprime loans are generally offered with high interest rates and terms that are less favorable to the borrower.
Keep Up the Good Credit Rate
In order to obtain lower interest rates, try to get and keep your credit score more in the 650 and above range. And, if you can, reach for the 700 and above range for the lowest interest rates and loan terms that are more beneficial to you.
FICO® is a Registered Trademark
FICO® is a registered trademark for Fair Isaac Corporation, a company that developed a credit-scoring model used to evaluate and measure credit history. While there are other companies that do the same thing, most people are familiar with their FICO score; consequently, sometimes instead of saying credit score, they will say FICO score to represent their credit history report.