Everyone knows that you need a good credit score to get a loan, but how do you calculate a credit score? Let’s look first at what a credit score is. A credit score is a number that lenders use to determine whether they should offer you credit, and what interest rate you qualify for. Whether it’s a credit union, a credit card company, or a mortgage company, these lenders examine your credit report to learn how you’ve managed your finances in the past. They will all want to be sure that you will repay your loan on time. In other words, they want to know your creditworthiness: your credit score assists lenders to determine the level of risk involved in lending you money.
7 Factors Used in Calculating Your Credit Score
Many factors can influence your credit score. The most common credit scoring factors on your credit report are:
- Payment history. Your individual credit score will reflect all of the payments you have made, both on-time as well as late or missed payments. The payment history is the most important factor used to calculate your credit score.
- Credit utilization ratio (capacity). This compares the total amount of credit you are currently using with the total amount of credit available to you. To have the best credit score, keep your balances less than thirty percent for each account. For example, if you have a credit card with a $10,000 limit, be sure to keep the balance owed on that card below $3,000.
- Total debt load. This is the sum of all of your debts, such as loans, collections, credit cards, and other credit accounts.
- Credit mix. This looks at the different types of credit accounts you are using, including things like mortgages, auto loans, credit cards, and store credit.
- Credit Account age. Lenders want to see an established history with on-time payments as well as the amount of time you have had established credit with the various lenders. Older histories have less of an impact on credit scores than more recent histories.
- Hard inquiries. When someone runs a credit check on you, this is known as a hard inquiry. Too many inquiries will lower your credit score. Avoid unneeded inquiries.
- Public records. This is your public history which can include tax liens, bankruptcies, or civil judgments. These balances will need to be paid off to increase your credit score. Settlements, or a negotiation to release a judgment for an amount less than the original debt, may also reflect poorly on your credit score.
You Have More Than One Credit Score
Credit scores are a complicated subject. You might even find out that you have more than one type of credit score. Why? Let’s find out.
Credit scoring agencies use a proprietary algorithm to determine creditworthiness, but rely on the factors described above when making those calculations.
For example: The three major credit bureaus, Experian, Transunion and Equifax use the FICO algorithm, first introduced in 1989 and used by the majority of lenders. VantageScore, a newer model introduced in 2006, uses a different algorithm to create a more predictive and consistent rating system.
|FICO FACTORS||VANTAGESCORE FACTORS|
|Payment history: 35%||Recent credit amount: 30%|
|Outstanding debts: 30%||Payment history: 28%|
|Length of your credit history: 15%||Credit utilization: 23%|
|Types of credit you’ve used: 10%||Account balances size: 9%|
|Amount of new credit: 10%||Depth of the consumer’s credit: 9%|
|–||Amount of available credit: 1%|
You will also have a credit score with each of the credit reporting agencies: Equifax, Experian, and TransUnion. Your score with each of these agencies is most likely very similar, but there may be discrepancies. Some credit reporting agencies may not update their information as rapidly as others. For example, if you have recently paid off a loan, it may appear in Equifax but not have been updated in Experian, thus giving you a lower credit score on Experian.
Experian v. Equifax v. TransUnion
Each credit bureau has its own name for its credit scoring model, even though they all use the same FICO algorithm. Experian calls it “FICO or FICO II,” Equifax uses “Beacon,” and TransUnion’s model is named “Empirica”. To make thing even more complicated, there are specialized credit scores used by lenders for specific types of loans. If you are applying for a car loan, for example, lenders look at your Auto Enhanced score which gives more weight to your auto loan payment history. So, if you paid your mortgage and credit card payments in full and on-time, but your car loan payment was always late, that will reflect negatively in your Auto Enhanced score.
Where do I go From Here?
Calculating your credit score does not have to be overwhelming. Doing a couple of simple tasks will get you on the way to your score.
First, you need to keep track of your credit report. Regularly checking your credit report with a program like CreditKarma.com does not reflect negatively on your overall score, and you can take action if you notice something out of place. Each credit bureau has their own online system used to clear up discrepancies, and they are required to respond within 30 days of a properly submitted dispute.
Start shopping for a mortgage lender well in advance of home buying. Discover which credit score your lender uses, and focus on that score. All mortgage lenders use Experian, Equifax and Transunion. Your mortgage lender can help you find the best way to calculate your score with each of these credit bureaus, and offer creative solutions to increase your over-all score before you apply for a pre-approval.
Speak with a knowledgeable mortgage planner today to put you and your credit score on the right track for the purchase of your dream home. Interest rates are currently the lowest they have been in over one year. Apply for your preapproval at Sammamish Mortgage now, to lock in the benefit of these lower rates.