FICO Scores, Credit Scoring and Mortgage Lenders

FICO Scores, Credit Scoring and what it really means to mortgage lenders.

Throughout my career, I always hear different myths about credit scoring and what does or does not hurt your FICO score. I would like to take this opportunity to put some of those misconceptions to rest and get you on the correct path of achieving and maintaining a great credit score.

Let's first start off by defining exactly what a FICO score is because there is so much misinformation out there. Wikipedia neatly sums it up:

"The FICO mortgage score is between 300 and 850. Higher scoresindicate lower credit risk. Each individual actually has 49 credit scoresfor the FICO scoring model because each of three national credit bureaus, Equifax, Experian and TransUnion, has its own database."

The importance of a good credit score these days is simple, with all the tightening in the lending environment, banks and lenders are looking at your credit report like a "report card" to determine if you're a quality borrower. The lower the credit score, the higher the cost of financing will be (if even available), and the higher the risk for lenders. Conversely, the higher the credit score, the cheaper financing will be for you because you are seen as less of a risk to lenders. Now let's take a look at some falsehoods I constantly encounter: Falsehood #1: Closing old credit card accounts is good for my credit score, right?

WRONG! The credit scoring models look at a few things when determining your credit score. First, they take into account the length of time an account has been open and active, the longer the account has been opened, the better. If you go ahead and close an account that hasn't been used in a while, you just wiped away years of credit history on that account.

Essentially you've just erased your history and turned your good "old" credit to very "young" credit. It is true that having too much credit can hurt your scores but you should know that having too many credit balances is what hurts your score, not too many open lines of credit. Ideally, you should never have no more than a 30% balance to limit ratio on any revolving account, i.e. credit cards.

So, if you have a credit card with a $1,000 limit, never carry any more than a $300 balance at any given time. Even if you pay the card off monthly, the balance that typically reports to the credit bureaus is the one that shows up on your monthly statement. If you want or need to improve your credit score, work on paying down debt, not closing accounts!

Falsehood #2: Credit card offers are ruining my credit score!

This, again, is wrong. When credit card companies are looking over potential customers' credit history, they are not doing a full credit inquiry...that's why if you call them, they have to approve you at that point. The "pre-approval" is just a marketing tool and does not mean they will grant you the credit limit or terms advertised.

Acting on these offers or constantly applying for new credit is what will hurt your credit score. Too many new accounts and you'll surely see your credit score reduced significantly.

In addition to this, checking your credit score from third parties will negatively affect your credit rating. I would recommend that if you do check your credit report and score, you do so directly from one of the three credit bureaus: Trans Union, Experian, & Equifax. By law, you are allowed to get 1 FREE copy of your credit report each year from all three bureaus; you will however need to pay for your FICO score from them, as that is not free. Don't be fooled by all the companies out there offering your credit score for free. Typically, those scores are not accurate, as they are not your FICO score.

Credit scores will range with all three credit bureaus and there's nothing better than going straight to the source for all your credit inquiry needs.

720 +: Wonderful! You are at the top with the best rates and terms available 700-719: Excellent score! You are a very desirable borrower. 680-699: Good Credit. You should be in strong shape to buy or refinance. 660-679: OK Credit. Don't look for other exceptions. 640-659: Borderline. OK if everything else is strong. 620-639: Weak. The rest of your file must be perfect. 600-619: Difficult. Needs some work or a special program. Below 600: Trouble! Try to fix up your credit!

Next week I'll be posting Part 2 of this blog! If you have any questions on anything in this blog, or about home loans please fill out the contact request form, and I will be in touch ASAP!

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