Credit Score - What is Considered Good?
Lately there’s been a lot of talk about credit scores and also a lot of confusion. It’s true that a higher score often leads to more favorable loan terms which in turn can translate into considerable monthly savings. But what’s unclear is how high a credit score needs to be to reap these financial benefits. The following information is designed to help clear up some of the confusion regarding the credit score.
Calculating the credit score
Credit score calculations are complex for two reasons. First, a number of different factors go into their calculation. And second, in addition to calculating a base score, an individual’s credit profile is compared to other individuals with similar credit profiles. This careful evaluation of information and profile comparison helps lenders quickly and objectively determine how big of a financial risk you are perceived to be.
The FICO score, named after the outfit that devised the formula for calculating the score, is the most commonly used credit score calculator in the United States. Its scores range from a low of 350 (indicating an individual is a high credit risk) to a high of 850 (very low risk). This scoring process uses information obtained from Experian, Equifax, and/or TransUnion, which are the three primary credit reporting agencies, to calculate an individual’s credit score.
The information from the credit profile that is used for calculation purposes includes your total amount of non-mortgage related debt (for example, credit cards, student loans and auto loans), and your account payment and credit history. Keep in mind that credit agency data is not always accurate and inaccurate data can significantly affect your score. See below for information on what you need to do to ensure the accuracy of the information being reported.
Your credit score isn’t all that matters
While your credit score plays a significant role in determining whether or not you’ll be approved for a car or home loan and the terms you’re offered if you are approved, it is not the only factor that lenders take into consideration. Besides looking at your payment history, lenders also consider your current income and your income potential. Why? Because how much you earn and how much you have the potential to earn gives them a good idea as to your ability to repay a loan. Interestingly, two applicants with similar good FICO scores may very well be offered different loan terms when income and income potential are factored into the credit evaluation process.
How big a role your credit score plays in the credit evaluation process differs based on the type of loan for which you apply, too. Because of the amount borrowed and the longer loan terms, credit scores play a more significant role in the mortgage approval process than they do when applying for a store credit card. However, the type of mortgage product applied for is also taken into consideration. Someone with a lower credit score that is applying for a shorter term loan and putting up a sizeable down payment may be offered better terms than someone with a higher credit score seeking an adjustable rate mortgage.
The lender’s portfolio is also something that often is considered. Lenders with portfolios that include more high risk customers may, going forward, only offer prime rates to applicants with higher scores. On the other hand, if a lender’s portfolio contains more low risk customers, the lender may be willing to add more applicants with lower credit scores. That is partly the reason why different lenders oftentimes offer different rates on similarly requested mortgage products.
You can improve your score
When it comes to your credit score, there is usually plenty of opportunity to improve it. Credit agencies frequently report inaccurate data so it’s in your best interest to always know what is on all three of your credit reports. Once a year you’re entitled to a free copy of your credit report from each of the three major credit bureaus. Take advantage of this offer and carefully scrutinize each. If you find discrepancies, it is in your best interest to take immediate steps to correct them.
Something else that can improve your credit score is limiting the number of credit applications you fill out. When a credit card company solicits your business, this is considered a “spot” inquiry; a type of inquiry that won’t affect your credit score. However, when you apply for credit, this is considered a “hard” inquiry which does get reported. Too many hard inquiries into your credit profile in a short timeframe will negatively affect your score. Note however that applications for car loans and mortgages are considered differently and don’t usually affect your score. Although inquiries play a role in credit score calculations, they account for only a small percentage of the total score.
The biggest concerns on your credit profile, and the things lenders focus on most, are your outstanding balances and your payment history. Bankruptcies, foreclosures, late payments, having high open to spend balances, and balances that are near credit line limits will lower your score and should be avoided. Just remember, negative marks on your credit report can, over time, be turned into positive marks.
It’s okay to be concerned with your credit score, just don’t obsess over it. It’s okay to have open credit accounts. In fact, they’re needed to establish a credit history. It’s just that with today’s lending standards tightening, it is in your best interest to always manage credit wisely.