DECODING YOUR CREDIT – Part I Credit Basics
Are you interested in buying your first home? Or are you are a seasoned home buyer or looking to start investing in rental properties? Your mortgage rate can often make or break a potential investment. In order to get the best mortgage rate, you need to have your credit on point.
In this series on credit scores, we’re taking a look at understanding the basics of a credit score, methods to boost your score, strategies for protecting it, and finally a Q&A session with Jessica, a Mortgage Banking Officer with BBVA Compass.
DECODING CREDIT PART I
A Tale of Two Scores
When my husband and I were in the process of buying our fourth home, we were joking about which one of us was going to have the better credit score when our lender was pulling our credit to get us pre-approved. Well, my husband opened up his credit report first, basically a perfect score. Cool, I thought, that means I’ll probably have a perfect score too. In the seven plus years we’ve been married, we’ve paid our bills on time, bought cars, sold cars, bought houses, done the DirectTV thing, paid off our cell phones, carried mortgages, paid off a mortgage…you get the idea, we’re upstanding credit citizens. Well, I was shocked to see that my credit score was almost 65 points below my husband’s. His credit was in the “exceptional” category and mine was in the “very good” category, my lender went further to say that means I’m very dependable (I’m sure he threw in a military dependent joke in there somewhere too). For those of you that know me in real life, I’m slightly competitive. This was not going to fly. I set out to learn more about my credit score.
Who Owns My Credit Score?
In the United States, there are three major credit bureaus, Experian, Equifax, and TransUnion, that report on your credit. Each one of these bureaus will report their own FICO Score based on the credit information that they gather regarding your credit. What’s a FICO Score you ask? The Fair Isaac Company aka FICO owns the algorithm that calculates your actual score. Although there are other credit scores besides FICO, 90% of lenders use FICO Scores to make credit lending decisions. Even within FICO, there are different credit scores. For simplicity, this post will use the most common FICO Score, the FICO Score 8.
How is My Credit Score Calculated?
Your FICO Score looks ONLY at the information that is in your personal credit report. It doesn’t look at information such as age, race, gender, marital status, where you live, or employment history. Check out the pie chart below. There are five elements that make up a FICO credit score and nothing else.
Payment History (35%): This is the big hitter. Do you pay your bills on time? Lenders want to know. Not all bills are created equal either. A missed credit card payment might drop your score, but missing a mortgage payment can cause a potential drop of more than 100 points! Ouch.
Amounts Owned (30%): This is a tricky one. It’s good to pay your credit card statement in full every month to keep a zero balance. That looks good for your payment history, but it doesn’t look good for your amounts owned if you max your cards out every month, even if you pay them in full. Your “credit utilization ratio” plays a big part in your score. You’ll even see it show up on your credit report. In addition, new mortgages or brand new car loans will have a very high credit utilization ratio. It’s not a deal breaker, but as you pay down those big loans, you’ll see your score improve.
Length of Credit History (15%): An older credit history can help to increase your score. However, just because you are new to credit, doesn’t mean you can’t have a high score, since this segment only makes up 15% of your score. This segment looks not only at how long your oldest accounts have been open, but also how long it’s been since you’ve used those accounts. Although its good advice to often keep a credit card with a long credit history open, it’s also a good idea to use it every once in a while as well.
New Credit (10%): The average age of your credit accounts helps to determine this portion of your credit score. Opening several new credit accounts in a short period of time won’t look good for your score. Only open credit lines when you really need them, and try to space them out as much as possible. Don’t be a card hopper. Opening and closing credit cards like your refrigerator door isn’t going to sit well with FICO either.
Credit Mix (10%): FICO Scores evaluate all the different types of credit you might have. Do you just have credit cards? Or, do you have several different types of credit such as credit cards, mortgages, installment loans (like a car payment), retail accounts, or finance institution accounts? Since its only 10% of your score, it’s not a huge deal if you haven’t had the opportunity to experience several different types of credit, but it’s something to keep in mind when building your credit.
What’s a Good Score?
FICO Scores can range from 300-850 and anything above 670 should be your goal. Interestingly enough, 20% of the population makes up about each one of the five brackets.
Applicants in the lower brackets may have to pay additional fees, receive higher interest rates, or may not qualify for credit at all. In contrast, the higher your score, the better rate you will receive from your lender.
Where Can I Find My Credit Score?
Did you know that by law, you are entitled to a FREE credit report from each of the three major bureaus once a year? Annualcreditreport.com is the only authorized site from the Federal Trade Commission. There might be other sites, but this one has been verified. It literally takes 5 minutes to fill out the form and you will be able to instantly download your credit report from all three agencies. Mark the date you pull your credit on your calendar, and do it faithfully every year to keep tabs on your credit.
However, you will not find your credit score on your credit report…weird, right? The credit reports are free, but if you want to see an actual score you gotta pay extra for that. Most major credit cards these days will show you your monthly FICO Score for FREE. Personally, my USAA and American Express cards show me my FICO Score from Experian and my Discover card uses TransUnion credit to report my FICO.
What did I learn?
Even though I have a “very good” credit score, now I understand why my husband’s is higher than mine, even though we live in the same household, share the same expenses….and I’m actually the one who manages all our bills.
I’ve determined that one of the biggest factors is that he’s is six years older than me. I can already picture him shaking his head at me right now and calling me a sore loser, but those six years does a lot more things for his credit than mine. For starters, his credit history is six years older than mine, and his credit card with the longest history was opened when I was still in high school – before I had a credit history. In addition, due to the SRCA benefits of which we take advantage, we often put financial matters (debt) in my husband’s name. The only car loan I’ve ever paid off was from before I was married. We recently paid off one of our mortgages, but it was a house my husband bought before we were married, and the loan was in his name, which didn’t help my credit at all. You get the picture. So, my husband wins Round 1 of the credit battle, but now that I know the ins and outs of credit scores, I have the tools to improve my score.
Now that we understand the basics of credit scores and how to pull a credit report, in Part II of Decoding Credits Scores, I’ll teach you how to boost your credit score so you can be poised to get the interest rates available to you.