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The FIVE Factors of Credit Scores
Sep. 24th, 2009
YUMA, AZ – The credit score system used today has evolved since the 1960’s.
This system was originally designed to provide lenders with financial profiles on consumers who wished to borrow money. The lender’s biggest concerns are whether the loan will be repaid, and calculating the associated risk with that loan.
The credit score is a statistical model which seeks to quantify the likelihood of a consumer to pay off debt without being more than 90 days late at any time in the future. Credit scores can range from a low of 350 to a high score of 850. Only one out of 1,300 people in the United States have a credit score of 800. Conversely, one out of every eight home buyers are faced with the possibility that they may not qualify because they have a score falling between 500 and 600.
There are five factors that comprise the credit score model. They are listed in order of weight by the credit bureaus.
Payment History (35%) Paying debt on time and in full has the greatest positive impact on your score. Late payments, judgments, and charge-offs all have a negative impact. Missing a high payment will have a more severe impact than missing a low payment. Delinquencies within the last two years carry more weight than older items.
Outstanding Credit Balances (30%) This is the ratio of outstanding balance as compared to the available credit line. Ideally, the consumer should make an effort to keep balances paid off; however, anything up to 30% is considered a limited risk. 30% to 50% is marginal and will have a negative affect on the score, and anything over 50% of the available limit is actually NEGATIVE credit and will severely decrease the credit score.
Credit History (15%) This is the length of time since a trade line has been established. A long term borrower will always score stronger than someone who has just opened new trade lines.
Type of Credit (10%) Mortgages are best, auto loans are next, and revolving debt is the least desirable from a scoring perspective. A mix of these is better than a concentration of debt from credit cards only.
Inquiries (10%) This percentage of the credit score quantifies the number of inquires made on a consumer’s credit within a six-month period. Each inquiry from a lender/vendor can result in a two to 25 point reduction in credit score. Note that 11 or more inquires will have no further impact on a borrower’s credit score. Additionally, a credit report run by the individual for verification purposes will have no impact on your score.
Remember that the credit score is a computerized calculation. Personal factors are not taken into consideration when a credit report is generated. It is merely a snapshot of today’s credit profile for any given borrower, and it can fluctuate dramatically within the course of a week.
How can you control your credit score? Where payment history may not be changeable, you do have control over an immediate 40% of your score. Looking at the above items, you CAN control Inquires and Outstanding Balances. Immediately stop credit inquires for over a six month period. Remember every time you apply for a credit card, cell phone, department store card, any credit to be extended, you will affect your score. The largest area to be controlled by the consumer(s) would be the Outstanding Balances. If one looks at the current revolving debt as related to available credit, redistributing that debt or paying down debt so that less than 30% of the credit is encumbered will immediately increase your score. DO NOT CLOSE ANY ACCOUNTS!!! This is the biggest myth concerning consumer credit scores. Not only do the models look at individual trade lines for Balance ratios, but they also look at totals. Assume John Doe has four credit cards with $3000 limits and a total of $3000 owed. If he distributed $750 on each card, his balance to limit ratio is 25% on each card and 25% on total debt to limit ratios, which is considered minimal by the scoring models. If he distributed that debt to one card he would be maxed out to 100% of the single trade line, which is very negative. However he would still have three cards at a zero balance. This is not nearly as good as the first scenario, but his total debt to total limit is still 25%. Now if John Doe was to close the three unused credit cards and leave the $3000 on the remaining card, not only would he be 100% charged on his credit card, but he is charged to 100% of his total available credit. From a statistical scoring perspective, the worst thing that can be done by an individual is to close zero balance accounts.
The three largest credit bureaus (Experian, TransUnion and Equifax) have created a central web site, www.annualcreditreport.com to accommodate Americans who wish to obtain copies of their credit reports.
Derek Egeberg is Certified Mortgage Planning Specialist, CMPSR, with over 9 years of residential lending experience. If you have any further questions on this topic or any other, you can contact Derek at [928-314-1008] or email Derek@TheApprovalCoach.com.
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