What Is A Credit Score And How Is It Determined?
A credit score is a three-digit number that can have a big impact on your life. If you’re trying to finance a home purchase, a potential lender will use your credit score as a determining factor.
Even the most financially savvy consumers have a difficult time grasping the topic of credit. Many people understand that a good credit score usually translates into higher approval chances and better loan terms, but understanding the meaning of a credit score and how it’s calculated can be more challenging.
Below, we’ll dive into exactly what a credit score means.
What Is A Credit Score?
A credit score is a number that indicates your level of creditworthiness. It’s an easy way for potential lenders to determine what kind of a risk you are to them.
If you have an excellent credit score, the lender assumes you’re not a risky investment. With that determination, they can offer you better loan terms upon approval. If you have poor credit or no credit at all, a lender is less likely to take a risk with you.
The credit score itself is based on your credit report. Equifax, Experian and TransUnion® are the three major credit bureaus that hold your credit report. A credit report is just a record of transactions that are related to your credit history. For example, it would show things like your credit card balances and a record of missed payments.
The most common credit score is the FICO® Score created by the Fair Isaac Corporation. Your score will fall into one of five categories:
- Poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very Good: 740 to 799
- Excellent: 800 to 850
If your score is in the “good” range or higher, you’ll have less trouble securing a home loan. Although you’ll have more difficulty finding a lender with “fair” credit, it’s still possible. For example, with a 580 FICO® Score, you can qualify for an FHA loan with Quicken Loans®.
How Is A Credit Score Determined?
Although the exact scoring model used by lenders may vary, most are based on a variation of the FICO® Score.
FICO® pulls information about different variables from your credit report to compile your score. The score looks at payment history, the total amount owed, length of credit history, account types and new credit. After pulling information off your credit report, FICO® creates a score between 300 and 850.
Let’s take a closer look at those factors.
Payment history is a record of your past payments. It shows whether or not you’ve consistently made on-time payments to your accounts. If you have a poor history of making on-time payments, the score predicts similar actions in the future.
Since payment history accounts for 35% of your total credit score, it’s the highest weighted factor. An easy way to boost your credit score is to start making on-time payments regularly.
Credit utilization measures how much credit you have available and how much you’re using. Essentially, it’s the total of your credit balances divided by your total credit limits.
If you max out all of your credit cards, your credit utilization rate would be 100%. It’s good practice to keep your credit utilization rate low because it accounts for 30% of your overall credit score. Not only will a low utilization rate help your credit score, but it will also leave some breathing room in case of an emergency.
Length Of Credit History
Length of credit history evaluates how long you’ve been managing your credit. The score has nothing to do with your age, only the age of your accounts.
If you’ve had credit accounts opened for many years, that will improve your credit score. This factor accounts for 15% of your FICO® Score.
New credit assesses what accounts you’ve been opening recently, and it accounts for 10% of your overall credit score. If you open many lines of credit all at once, you can negatively impact your score.
Even if you only inquire about credit multiple times within a short period, that can hurt your credit score. Be careful when making hard inquiries into a new line of credit!
Types Of Credit
The last 10% of your credit score is what types of credit accounts you already have. You might have revolving debt (such as credit cards) or installment loans (such as a mortgage). A mix of both types will positively impact your credit score. However, it’s not as highly weighted as some of the other factors.
Where To Access Your Credit Score
It’s a good idea to find out where your credit score stands. You’re entitled to one free copy of your credit report from each of the three major bureaus each year. That said, you might want to check your credit score more often than that.
Rocket HQSM allows you to monitor your credit on a weekly basis. Each week, you’ll have access to your updated VantageScore 3.0® score as well as a look at your TransUnion® credit report.
The Bottom Line
Your credit score can have a huge impact on your life. Many of us have plans to finance a place to call home in the future, which might not be possible with a poor credit score.
Take a look at your credit score and work on improving it. You can start by committing to on-time payments and taking steps to reduce your credit utilization rate. Both will have a big impact on your score.
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