What is a credit score?
Before deciding on what terms they will offer
you a loan (which they base on their "risk"), lenders
want to know two things about you: your ability to pay
back the loan, and your willingness to pay back the loan.
For the first, they look at your income-to-debt obligation
ratio. For your willingness to pay back the loan, they
consult your credit score.
The most widely used credit
scores are FICO scores, which were developed by Fair
Isaac & Company, Inc. (and they're named after their
inventor!). Your FICO score is between 350 (high risk)
and 850 (low risk).
Credit scores only consider the information
contained in your credit profile. They do not consider
your income, savings, down payment amount, or demographic
factors like gender, race, nationality or marital
status. In fact, the fact they don't consider demographic
factors is why they were invented in the first place. "Profiling" was
as dirty a word when FICO scores were invented
as it is now. Credit scoring was developed as a way
to consider only what was relevant to somebody's willingness
to repay a loan.
Past delinquencies, derogatory payment
behavior, current debt level, length of credit history,
types of credit and number of inquiries are all considered
in credit scores. Your score considers both positive
and negative information in your credit report. Late
payments will lower your score, but establishing
or reestablishing a good track record of making payments
on time will raise your score.
Different portions
of your credit history are given different weights.
Thirty-five percent of your FICO score is based on your
specific payment history. Thirty percent is your current
level of indebtedness. Fifteen percent each is the time
your open credit has been in use (ten year old accounts
are good, six month old ones aren't as good) and
types of credit available to you (installment loans
such as student loans, car loans, etc. versus revolving
and debit accounts like credit cards). Finally,
five percent is pursuit of new credit -- credit scores
requested.
Your credit report must contain at least
one account which has been open for six months or more,
and at least one account that has been updated in the
past six months for you to get a credit score. This ensures
that there is enough information in your report to generate
an accurate score. If you do not meet the minimum criteria
for getting a score, you may need to establish a credit
history prior to applying for a mortgage.
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