What Determines a Credit Score? Myths Debunked

Your credit history is the MOST important thing you need to be aware of and should always consider when making financial decisions. Your score is a snapshot of your historic and current ability to repay debt. Believe it or not, having debt can actually be a good thing as it pertains to generating credit scores. While there are several other factors, your credit history is the number one factor influencing your ability to borrow money. So why do your scores change so often? Why is your score lower today than when you received your free online report yesterday?

There are three credit bureaus that lenders pull information from; Trans Union, Equifax and Experian. They each generate a score, and we the lender use the median score as your qualifying score. If you are buying a home with a spouse, partner or co-borrower, we look at both median scores and then take the lower of the two for qualifying. People are often surprised that their score is lower than they expected. Often times people will tell me that they got a free report online and their score was much higher. Why is this? Each of the three credit bureaus use multiple scoring models and algorithms to determine your score. You may hear a credit score often referred to as a FICO score. This is the overlying scoring system. Fair Isaac Corporation (FICO) has multiple models that are updated and released from year to year. For example, Classic 04 and Beacon 5.0 are often used in the mortgage industry but can have a much more conservative scoring process than the models used when purchasing a car, or getting a free consumer report. So no, we cannot use your online credit report. We must pull our own report. And yes, it’s very important to have your lender pull your credit early in the pre-approval process to manage your expectations and help identify any potential issues or discrepancies you may be able to correct.

While the scoring algorithms aren’t public, we know what impacts your scores the most. And no, having your score pulled by multiple mortgage companies will NOT affect your score. I’ll dive into that later.

Pay your bills on time.
Your credit card won’t report you late until it’s 30 days past due, but get in the habit of paying early. I’ve seen a single 30 day late payment drop scores more than 50 points. If you continue to fall behind, multiple 60 and 90 day late payments will destroy your scores.

Revolving debt vs. Car Loans, Student Loans & Mortgages
Having good credit comes from a history of repayment. Car loans, student loans and mortgages can help develop a long term history of good credit standing. As long as these are paid on time, these are good items to have on your credit report. Revolving debt, i.e. credit cards, need to be tamed. Again, it’s okay to have credit card debt but read ahead on how to handle this debt.

Keep your credit card balances “low”
It’s perfectly fine to have credit cards. In fact, showing your ability to pay these cards on time is what generates a healthy credit record. The key however, is keeping your debt utilization low. What does that mean? Try to keep your credit card balances below 40% of the limit. Percentages are key! If you have a card with a $15,000 limit, then keep that balance below 40% or $6,000. Better yet pay that card off so your utilization is 0%. Somebody with a $25,000 credit limit with an $8,500 balance will likely have better credit scores than somebody with a $2,000 balance on a $4,000 card. Sure the debt is higher but the person with the higher credit limit has a lower utilization percentage. Be careful when opening cards to buy products. They often set the credit card limit to the cost of the product. I’ve seen this with somebody who bought a $2,000 television on a Best Buy card. Sure, it was no payment and no interest for 12 months. Great, right? Not for this person. The card limit was set to $2,000, so he was actually maxed out, 100% utilization, for several months.

Don’t close out old cards
As I mentioned, your credit history is important. When you close out a card, eventually that history attached to that account will go away. More importantly, your overall utilization percentage goes up. For example, if you have two credit cards with a $10,000 credit limit and the balance of one is $0 and the other is $4,000, your combined utilization is 20%. If you close out the zero balance card, your total utilization just went to 40%. Don’t trust yourself with that second card? Cut it up. Shred it. You don’t have to use it. I just don’t recommend you close it out.

Pay off collections
Sometimes the oldest collection can come back to haunt you. When you have a bad debt that the credit card company couldn’t collect on, they will sell that debt to a collection agency for cents on the dollar. The collection company will try to recoup dollar-for-dollar to be profitable, but often they’ll negotiate with you since they bought the debt for less than what you owe. If you don’t pay it, the debt could get sold to another collection agency years later. This could bring it back to life on your credit report where you’ll once again get “dinged” with late payments.

Write letters
If you find something erroneous on your credit report, contact the creditor and get documentation agreeing it was an error. Send that information to the three credit bureaus so they can correct the errors.

Credit Inquiries
Yes. Too many credit inquiries can affect your score. Just one credit check can have a negative but small impact, but just like your car, you need a checkup. Have it pulled annually to make sure nothing populates out of the ordinary. Think of it as a score card. You should visually see your credit history and see if there are ways to improve your scores. If you are having it pulled several times by several credit card companies, this for sure can impact your scores. The bureaus know that you’re attempting to acquire more revolving debt. They’ll penalize you for multiple attempts. A common misconception is that multiple pulls by a mortgage company will hurt your credit. As a consumer shopping lenders for your home mortgage, rest assured that multiple inquiries from multiple lenders will not affect your due diligence. The Consumer Finance Protection Bureau regulates this and states that multiple inquiries in a 45 day window will only register as 1 inquiry. Read More From The CFPB Here

There are many other factors that can affect your scores, but if you can pay your bills on time and keep your credit card balances low, you will find yourself on the path to 800. If you are in the early stages of purchasing a home or even just entertaining the idea, please give me a call so we can make sure you’re on the right path!

Written By: Chris Ulrich – United Home Loans
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