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Understanding how credit scores are calculated is critical to good credit management. In this section, you will find a complete overview of exactly how credit scoring works and what consumers can do to better manage and help improve their credit scores.
Let me remind you that credit is the lifeblood of business, the lifeblood of prices and jobs. – Herbert Hoover
Credit scores are determined by a mathematical model that evaluates the information contained in a consumer's credit report at a specific credit bureau at a specific time and compares it to the patterns in millions of past credit reports. The computation results in a single numerical score that represents the level of credit risk associated with that consumer. To calculate a credit score, a consumer's credit file must contain at least one account that has been open for a minimum of six months. In addition, the credit file must contain at least one account that has been updated within the last six months. These two criteria ensure that there is enough information (and, enough recent information) on which to base a credit score.
Five key types of information are used to calculate a consumer’s credit score:
Credit scores review a wide range of information on the credit report. However, they do not consider the following:
For some consumers, one particular factor may carry more weight than it does for someone else with a different credit history. For example, late payments by a consumer with a bankruptcy on their credit file may lower a credit score by a greater number of points than it would for a consumer with an otherwise positive repayment history.
In addition, as the information in a credit report changes so does the importance of any factor in determining the score. Therefore, it is impossible to say exactly how important any single factor is in determining a score. The benchmarks for relative importance of different types of credit information are based on trends within the general population and will therefore vary by situation. What is important is the mix of information, which will vary from person to person, and for any one person over time.
Remember, lenders look at many things when considering a credit decision including income, term of employment, and the kind of credit being applied for, just to name a few.
We'd like to know a little bit about you for our files, we’d like to help you learn about yourself… - Simon & Garfunkel
Payment history typically accounts for approximately 35% of a credit score. It is one of the most important factors in a credit score.
However, a few late payments will not necessarily kill a credit score. An overall good credit picture over several years can compensate for one or even two instances of late credit card payments. Conversely, a complete absence of late payments does not guarantee a "perfect score".
Approximately 65% of all credit reports show no delinquency at all so you must remember that payment history is just one area looked at when developing the credit score.
The following factors are considered for payment history:
Also, even after a collection account, judgment, or tax lien is reported as paid, the account is still regarded as seriously delinquent because it went to a collection status. It is always responsible to payoff all collection accounts, but it is advisable to do so only after the close of escrow when buying a home. Doing so prior to the close of your home can cause your credit score to go down.
A 60-day late payment is not as bad as a 90-day late payment. But, how recently the late payment occurred and how often it has reoccurred are both important factors. For instance, a 60-day late payment that just occurred last month will have a greater negative affect on a credit score than a 90-day late payment that occurred 4 years ago.
Closing an account on which a consumer was delinquent does not remove the negative item from the credit report. Keep in mind, however, that a 30-day delinquency is not considered a serious delinquency. A 60-day or greater delinquency is considered serious. Although a 30-day delinquency will affect the credit score negatively, it will not be as great an effect as a 60-day or greater late payment.
It is best to manage credit proactively and responsibly over time:
To learn more about how to correct inaccuracies on your credit report, visit our Credit Disputes page.
You can observe a lot by watching. - Yogi Berra
The current amount owed on your accounts typically accounts for approximately 30% of a credit score.
Owing money on the credit accounts you have does not mean that your credit score will be lower or that you are a high-risk borrower. However, owing a large amount of money on many different accounts can indicate that a consumer is overextended on their credit and is more likely to make late payments or default on their obligation to repay the loans. Credit scoring tries to determine how much is too much for a particular individual.
The following factors are considered regarding amounts owed:
Opening a new account with a high balance relative to the credit limit and closing existing accounts usually lower credit scores for many months until the balance drops below 50% of the credit limit and until the account has been open for a year.
Bottom line: If you are in the market for a home now or are thinking about purchasing a home in the next 12 months, you should try to avoid this common mistake.
Length of credit history typically accounts for approximately 15% of a credit score.
Generally, the longer the credit history the higher the score. But, even individuals who have not been using credit for very long can have high scores, depending on many other factors in their credit report.
The following factors are considered for length of credit history:
Credit scoring systems look at each account on your credit file and review them through a proprietary algorithm that uses this information alone and in relation to other information on your credit file to determine the likelihood for repayment or delinquency.
Information that factors into the development of your credit score includes current or late payments, how late the payments are, number of open accounts you have, how much credit is being used by you in relation to how much credit you have available, and whether there are serious delinquencies on your file like bankruptcy, liens, and charge-off accounts.
Fair Isaac scoring models place a great deal of weight on how recently you had a credit problem. In a proportional sense:
Your credit score is like a picture taken by a camera that is developed at the time of inquiry by a credit grantor pulling your credit file. Your credit score can change with the passage of time as well as with the addition of new information to your credit file. As delinquency information in your file ages its negative affect on your credit score lessens.
For every complex problem, there is a solution that is simple, neat and wrong. - H.L. Mencken
New credit inquiries typically account for approximately 10% of a credit score.
Research has shown that opening several accounts over a short period of time typically represents a greater risk of default, especially for people without an established credit history.
New requests for credit (such as are generated when a lender requests a copy of an applicant's credit report) can affect a credit score in a similar way. However, credit scores do an excellent job of telling the difference between rate shopping (which is usually not associated with higher risk) and searching for many new credit accounts.
Inquiries remain on a credit report for two years but credit scores only use the inquiries listed on the credit report from the most recent 12-month period.
When a consumer directly requests a personal credit report (in order to review for accuracy), that request does not affect the computation of the score. The score computation also does not include any inquiries a lender makes in order to make the consumer a "pre-approved" credit offer.
There have been recent changes in how FICO models count inquiries for scoring purposes. It is a very complicated algorithm but the basic premise is that all auto- and mortgage-related inquiries made within a 14-day period are counted only as one inquiry for scoring purposes. The score computation also ignores all inquiries within the last 30 days of scoring. To help minimize any possible negative impact when shopping for mortgage rates, try to make all your inquiries within a 2-week period.
Re-establishing credit and making payments as agreed after a period of late payments will help to raise your score over time.
All right, everyone, line up alphabetically, according to your height. - Casey Stengel
The types of credit used typically accounts for approximately 10% of a credit score.
The credit score computation considers the mix of credit cards, retail accounts, installment loans, mortgage loans, and finance company accounts. Though the credit mix is usually not a key factor in determining the score, it can become more important if there is not a large amount of credit information on which to base the score.
The following factors are considered for types of credit used:
Here are the ten most common credit mismanagement mistakes that can result in a lower credit score:
CreditXpert is a “score improvement report” that is prepared using the information in your credit file. Available through a Birchwood mortgage broker, CreditXpert analyzes the individual accounts in your credit file in order to identify opportunities to improve your credit score.
Based on this analysis, CreditXpert recommends specific actions you can take to raise your score and also estimates the increase you can expect for each of the recommended actions. As an example, it can tell you that moving a portion of one account balance to another account is likely to result in a score improvement of “x” number of points. Some of the recommended actions will have an immediate effect while others may help you improve your score over time.
In order to affect your credit score, all corrections to your credit report must be made directly via the major credit bureaus (Equifax, Experian, and TransUnion).
For all the information on how to file a credit dispute, visit Credit Report Disputes.
If winning isn't everything, why do they keep score? - Vince Lombardi
Birchwood offers a service (available through our mortgage brokers) that allows consumers to expedite corrections to credit reports. The turn around time to address inaccuracies is usually approximately 3 to 8 business days (rather than the standard 30 to 45 days).
This service is available only to consumers who are in the process of applying for a home loan, and only through a Birchwood mortgage broker.
As with all credit report corrections, this expedited service makes adjustments directly with the three major credit bureaus. The process requires specific documentation as well as Birchwood’s validation of the error with the lender.
Required documentation includes a description of the error and written proof of the correction to be made. For example, copies of bankruptcy papers, lien releases, and letters from the lender on the lender's letterhead stating the correction to be made and signed by the lender, etc.
It is important to note that on collection or bankruptcy account corrections, the last date of activity shows the date that the collection was paid off or the bankruptcy was discharged with zero balances.
Birchwood will verify all written information provided and will transmit the verified information to the credit bureau that reported the error so they can verify, as well. The credit bureau then changes the data on their file, installs a block against future data update changes, and confirms that the change has been completed. The Birchwood mortgage broker is notified that the change has been completed so he or she can run a new credit report to compute a new score. There is no guarantee that the changes will result in a score increase.
For information on Birchwood mortgage brokers or lenders in your area please contact us or call 800-910-0015.