The most common credit score used by mortgage lenders in the United States is the FICO score. This score helps lenders determine a loan applicants creditworthiness and has a direct bearing on the terms that the lender is likely to offer any given individual. Generally speaking, the higher the FICO score, the lower the risk. This means that people with higher scores usually receive more favorable loan terms.
How a FICO score is calculated is a proprietary industry secret held in the strictest confidence. However, the FICO corporation has made available a general outline of what information they use in the credit scoring process. Knowing what makes up a FICO score empowers consumers to raise their scores by handling credit appropriately. Here is a list of the factors used in calculating a FICO score, including how important each kind of information is to the formula:
The most influential factor is ones payment history. This looks at the individuals history of making payments on credit accounts, and lowers the score for each late or missed payment. This factor is weighted at some 35% of ones FICO score.
Credit Used and Available Credit: This is an important ratio to a lender and it makes up 30% of your FICO score. Having plenty of available credit will raise your score. Also, paying down loans regularly but not closing them, and paying down your open revolving credit cards will increase the score. However, closing revolving credit accounts will lower the score.
Duration of Credit History: The FICO score is a tool to give creditors insight into how a person will behave if credit is extended. The longer the credit history the more information is available to indicate how a person will handle future loans. The longer your credit history the higher this part of your score will be. At 15%, it ranks third in weight for the scoring process.
Credit Diversity and Credit Inquiries: At 10% each these factors are still an important part of your score to understand. If a consumer has handled diverse kinds of credit appropriately it impacts the FICO score positively. However, if there are many inquiries into a persons credit the score will go down. The number of recent inquiries gives a lender a look at an applicants current financial picture, which is vital information when extending credit.
Knowing these factors and their relative weights can help the potential borrower modify their behavior in order to get a higher FICO score and hopefully more favorable terms for their loans.
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