A FICO Score Explained By MN Realtor

By the time you experience initiation into the adult world, you've probably heard the term credit score. It's a number you should be concerned about because others will be, and they will use it to judge your ability to pay back a loan.

So who cares about your credit score exactly? Credit card companies, banks, mortgage brokers, cell phone companies, insurance companies, and landlords, to name a few. Some companies even want to look at your credit score before offering you a job to see how responsible you are.

How is Your Credit Score Calculated

Your credit score is a number that captures your creditworthiness based on your credit history. Three major credit bureaus, Experian, Equifax, and TransUnion, track your financial information. The Fair Isaac Corporation takes this data and uses a model to assign a number known as a FICO score. Most creditors use this score to evaluate you when you apply for a loan such as a mortgage.  

The factors that FICO uses to calculate your score include

• payment history,
• amount of money you owe,
• length of your credit history,
• credit mix,
• recent requests for new credit.

Each of these categories determines a percentage of your score to create a snapshot of the state of your finances and your ability to take on more debt. Let's take a close look at each of the segments and how much weight they carry when tallying your credit score.

Payment History – 35 Percent of Your Score

The most weighty of all the categories, payment history answers the question of "if I lend you money, how likely is it that you will pay it back?" Do you pay your bills on time? If you are late, how late and how often? Paying bills on time consistently every month is the easiest way to improve your credit score. If you are behind in any payments, get current.

This category also considers whether or not you have filed bankruptcy, have any lawsuits or debt collection settlements pending or have garnishments on your wages. The more recent these are, the more they lower your score.

How Much Money You Owe – 30 Percent of Your FICO Score

Even if you currently pay all your bills on time each month, how close are you to having more debt than you can handle? Carrying too much debt is a big red flag to a lender, so they will look at what percentage of your income must go to paying debt each month.

Your credit utilization ratio, the percentage of your available credit you use, also affects your FICO score. Carrying high balances on credit cards will lower your number, which is why maxing out your credit cards is a horrible idea. Paying down your credit balances is a way to improve your FICO score.

Length of Credit History – 15 Percent of Your Score

How long have you had your credit cards? Your FICO score is a reason to establish credit as early as possible. A long history is preferable (providing you do not show late payments) because a short credit history hurts your score.

Also, be aware you need to use your credit. Just opening a line of credit and letting it sit does not establish a history of knowing how to manage credit. So using all your credit cards or accounts and paying them on time will improve your score. Likewise, do not close any accounts since you may end up removing your oldest one and shortening your credit history as a result.

Credit Mix – 10 Percent of Your FICO Score

What different types of credit do you have, and how well do you manage the mix is the concern of this category if you have an excellent record of managing student loans, car loans, credit cards, and mortgage payments that improves your credit score.

Credit mixture is a small percentage of your score, so it is not advisable to go out and open new lines of credit you do not need in an attempt to raise your FICO score.

New Credit – 10 Percent of Your Score

This category looks at how many recent new accounts you have opened. Each time you apply for new credit, there is a "hard pull" to check your credit reports and your credit score, and this act alone causes your score to dip.  Additionally, when you open too many new lines of credit, it may warn a lender that you are having a cash flow problem. 

Is My FICO Score Good Enough?

FICO scores range from 300 to 850. Ratings from 750 to 850 are considered excellent and secure those with the best interest rates. There are some instances where being above 800 is required. How many people have perfect scores? Only 1.2 percent of the population.

Here is a breakdown of the different ranges and how they relate to getting a home mortgage.

300-599 is not a good score and you probably will not qualify for a mortgage.

600-680 is meh. You may be eligible but you probably will not get the best terms. 

680-749 is a good score and you will qualify with a reasonable rate and standard fees.

750-850 is an excellent score. You will be rewarded with the best interest rate and the lowest fees!

 

Don't take it personally, even if your FICO score is bad or meh. It doesn't make you the wrong person. Chances are, before you read this article, you didn't know the importance of a FICO score and its effect on your financial life.

It's worth remembering that your credit score is not etched in stone for all eternity, and you can improve it before you apply for a mortgage. Keep in mind; a higher score means a lower interest rate, which is worth thousands in savings over the life of your mortgage.