The Five Categories of Credit

Five Credit Score Categories Best Mortgage Broker Dallas
When purchasing or refinancing a home, your credit scores can impact your potential mortgage interest rate and your APR. This is true for all types of loans: purchases, refinances, cash out refinances, home equity loans, HELOCs, home improvements loans, etc. Below is an outline of how credit scores are determined. A few “quick tricks” to improving your credit are paying down debt and increasing your credit limits.

There are five factors that determine your credit score:

  • payment history
  • debt utilization
  • length of credit history
  • type of credit
  • inquiries

Check out each section for the highlights of what you need to know.

Your credit scores usually determine the price you pay for your money (your mortgages, your auto loans and leases, your credit cards, business loans, etc.). Perhaps the most significant part of your credit report is your credit score. Credit scores range from 350 to 850, with 850 being the best possible credit score that you could receive, and 350 being the worst possible credit score. There are five factors that determine your credit score:

Payment History: 35%

To nobody’s surprise, paying your bills on time has the greatest weight of all the categories so pay your bills on-time. The credit scoring system evaluates how many late payments you have had and whether they were 30, 60, or 90 days late, or worse, in default. These systems look at whether the late payments were consecutive. Here are four practical (and obvious) steps that you can implement to improve your credit score:

  1. Make all your payments on time. (Duh!)
  2. Bring delinquent accounts to current as soon as possible.
  3. Pay your bills before they go to a collection agency.
  4. Check your credit report for accuracy on a regular basis and dispute any erroneous information.

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Paying debt on time and in full has a positive impact. Late payments, judgments, charge-offs, collection accounts and bankruptcies have a negative impact. If you have had any bankruptcies within the last 7 years, it will seriously affect your ability to borrow or establish new credit accounts. If you have had any judgments within the last several years, it is very important that you pay off the judgment and get a “satisfaction of judgment” from the court. Any unsatisfied or recent judgments will make a bad dent in your credit scores and adversely affect your ability to borrow. Usually, judgments and liens must be paid prior to the closing. Timely mortgage payments are weighted heavily by the scoring systems and are one of the most vital requirements that lenders look for when evaluating your credit history. Many times a single late mortgage payment within the last 12 months can hold up your file or spell the difference between the best interest rate and the next credit level. Your payment history on other debts (car payments, credit cards, etc.) is also given a lot of weight.

The credit scoring systems evaluate how many late payments you have had and whether they were 30, 60 or 90 days late, or whether they are currently in default, with default being the worst situation. Additionally the systems look at whether the late payments were consecutive. If you only have one or two minor late payments on your report with no other derogatory marks, your score will not be terribly affected, but you will have a tough time getting over the critical 700 level. Here are four practical steps that you can implement to improve your credit score in the area of “Payments”:

  • Make all your payments on time.
  • Past dues on any account will destroy your score – bring your delinquent accounts current immediately.
  • Pay your bills before they go to a collection agency.
  • Check your credit report for accuracy on a regular basis; and make sure that disputed bills are not negatively affecting your credit scores.

Debt Utilization: 30%

Debt Utilization is just a fancy way of saying: how much credit do you have available versus how much do you actually use. Therefore, it is not how much you owe, but how much you owe compared to what you are able to borrow. Keeping your credit balances below 50% is good and below 30% is even better.

A quick trick to increase your credit is to call your credit card companies and try to increase your available credit lines.

Example: If you owe $1,000, and you have $10,000 of credit available to you, you are only using 10% of your available credit line and the credit models love you. On the other hand, if you owe $1,000 and you only have $1,000 available for use, you have “maxed out” your available credit and your credit scores will be very negatively impacted.

Note: the scoring system doesn’t have a memory when it comes to balances. In other words, the credit models don’t care if your card was maxed out last month but paid now; or vice versa. The score is based solely on what’s reported at the time the time of the credit pull.

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The Balance You Owe vs. Your Available Credit Lines: 30% impact on your credit score

Keeping your credit balances below 50% of your available limit is very important. Keeping your balances below 30% of your available credit is even better. For instance, if you owe $10,000, and you have $100,000 of credit available to you, you are only using 10% of your available credit line. On the other hand, if you owe $10,000 and you only have $10,000 available to you, you have “maxed out” your available credit and your credit scores will be very negatively impacted. Therefore, it is not how much you owe, but how much you owe compared to what you are able to borrow.

Here are three practical steps to improve your credit score in this area:
  • Don’t close your credit accounts unless it is necessary to do so. It is better to have many open accounts with little or no balance than to have just one or two accounts regardless of the balance.
  • Don’t concentrate large balances on just a few accounts. Pay outstanding debt down as close to zero as possible, and evenly distribute the remaining balance across all your open credit lines. The key is to keep the balances down below 30% or at the very least 50% of your available credit line(s).
  • Call your credit card companies and try to increase your available credit lines if they can do so without pulling a new credit report.

Length of Credit History: 15%

The longer your accounts have been opened the more the credit models like you. Newly opened accounts will bring your score down for the first 12 months- but especially in the first 6 months – so don’t go opening any new accounts before (or during) the home buying process. Here are three practical steps for you to improve your score in this area:

  1. If you are going to close your account, close the newest credit cards instead of the oldest ones. Your score will improve over time if you keep accounts open and use them every once in a while. Call us before closing your accounts and we’ll be happy to offer advice on which tradelines you should close.
  2. Think twice before jumping on that latest 0% credit card transfer-offer or opening a new card just to get a 10% discount at a department store. New credit is seen as a sign of distress.  Don’t damage your credit for a random $23 savings at Nordstroms.
  3. If you don’t have much of a credit history, and you are planning on taking out a mortgage in the future, it may be a good idea to establish a few open credit lines with little or no balance on them. Although newly opened accounts tend to lower your score initially, they will improve your score once they’ve been open for a while, somewhat active, and paid off with little or no balance. Again, call us if needed.

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The longer your accounts have been opened, the higher your score will be; newly opened accounts will bring your score down. Here are three practical steps for you to improve your score in this area:

  • Don’t close your credit accounts. If you must, close the newest ones instead of the oldest ones. Your score will improve over time if you keep accounts open and use them every once in a while.
  • Think twice before jumping on that latest 0% credit card offer or opening a new card just to get a 10% discount at a department store.
  • If you don’t have much of a credit history, and you are planning on taking out a mortgage in the future, it may be a good idea to establish a few open credit lines with little or no balance on them. Although newly opened accounts tend to lower your score initially, they will improve your score once they’ve been open for awhile, somewhat active and paid off with little or no balance.

Type of Credit: 10%

A good mixture of auto loans, credit cards, and mortgages is always best. Ideally you should have a mortgage, an auto loan, and 3 credit cards. Again, this is “ideally” and a guideline. As stated above, credit is very specific to a person so call us if you have any questions.

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A good mixture of auto loans and leases, credit cards and mortgages is always best. Too many credit cards is not a good thing, and having a mortgage does increase your score. Practical steps to improve your score in this area include: (1) Having 3-5 revolving credit cards open is optimal.; and, (2) Having a good mix of auto loans, credit cards and mortgages is better than having only credit cards.

Inquiries / New Credit: 10%

Inquiries appear on your credit report for 120 days and are treated differently based on the type of inquiry.

“Soft” inquiries are made by companies that you already have accounts with and these types of inquires do not hurt your credit. For example, a credit card company will do a soft inquiry to view your current credit status and ensure you’re still a worthy credit risk – i.e. they’re looking for an excuse to increase your rate.

A “Hard” inquiry is any inquiry where your credit is pulled for new credit. These include credit cards, automobile, and mortgage companies. Here are three steps you can take to improve your score in this area:

  1. Multiple mortgage and automobile inquiries are treated as only one inquiry if made within 45 days of each other and typically don’t hurt your credit. So it’s better to shop for a car or a mortgage over a two-week period, rather than to prolong it over a longer timeframe.
  2. Don’t apply for a lot of credit or open multiple credit cards at the same time. New credit is seen as a sign of distress.
  3. If you’re thinking of applying for a mortgage within the next 90 days, it would be good to wait until after your home loan closes before you apply for any new credit.

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Inquiries affect the score for one year from the time they’re made. Your score isn’t impacted when you check your own report. It’s only affected if a potential creditor checks your credit. These include department stores, as well as credit card, auto finance and mortgage companies. Here are three steps you can take to improve your score in this area: (1) Multiple auto and mortgage inquiries are treated as only one inquiry if made within 45 days of each other. So, it’s better to shop for a car or a mortgage over a two week time-frame, rather than to prolong it over a longer timeframe. (2) Don’t apply for a lot of credit or open multiple credit cards at the same time; and, (3) If you’re thinking of applying for a mortgage within the next 90 days, it would be good to wait until after your loan closes before you apply for any new credit.

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