Credit Scores: What’s the Deal?

It is amazing the impact that credit has on our lives and how little most of us are formally educated on it.  Credit impacts many things from insurance, interest rates, and even the ability to get a cell phone or television plan without a down payment.  Many people feel like credit scoring is akin to witchcraft in how it is derived; I know myself I’ve felt like that at times.  Understanding credit scoring and the factors with it can help a person take control of their situation.

The 5 main things affecting credit include:

1. Payment history – making on time payments and avoiding 30 days or more late payments is imperative to maintain excellent credit.  This accounts of 35% of your FICO score.
2. Amounts owned – using available credit is a positive factor but it is important to try and not max out your available credit.  In industry we call this credit utilization ratio, it’s really simple – how much credit you are using divided by total available credit.  If you only have one credit card with a $10,000 limit and use $1,000 of it then you have a 10% utilization ratio.  Using more then 30% of available credit is negative to credit scoring.  Credit utilization accounts for 30% of your FICO score.
3. Credit history – how long you’ve had credit is important and makes up 15% of your FICO score.  Generally the longer you’ve had credit the better.
4. Credit mix – The people with the best scores have diverse types of credits – from credit cards to auto loans to mortgages.  Scoring models take into consideration how well you manage having different types of credit, this accounts for 10% of your FICO score.
5. New Credit – the number of new accounts opened and number of times you have your credit pulled impacts your score.  Too many new accounts or inquiries can have a negative impact.  Running your credit multiple times in a short time frame when shopping for an interest rate on an auto purchase or mortgage is treated as one inquiry fortunately.  This accounts for 10% of your score.

The average credit score in the USA is 698.  In the mortgage world conventional products are typically available with scores above 640 and FHA down to 620.   Some lenders will consider those with scores all the way down to 500 but one can expect a much more difficult process and much higher interest rate/cost of money.