Lenders Want the Entire Credit Score Story

The difference between a credit report and a credit score is the difference between a chapter and the entire novel. The novel tells the complete story, and when it comes time to get a mortgage, you definitely want to tell your lender as complete a story as possible. The reason that your score is more important is because while your credit report says what you have done in the past, your credit score predicts how likely you are to pay your bills in the future. Your credit score will also go a long way to determine what interest rate you will pay on your mortgage.

"We were looking at how to leverage the information that is generally available on credit histories and reports in ways that would benefit lenders," explained Craig Watts, consumer affairs manager for Fair Isaac Corp. This is the company that created the first credit score system back in the 1980s-the one referred to as FICO. "It was the first general purpose credit risk score. Prior to that credit scores had been tailored for a specific company or specific industry," said Watts. "We proposed broadening it to answer the question: What is the likelihood that this consumer will become delinquent in paying back one credit obligation in the next couple of years?" Mortgage lenders like to see a general credit score so they can see a person's overall history and study how they handle all of their obligations. Complicating the development of a general credit score was the fact that each of the major credit reporting companies‹Experian, Trans Union or Equifax-structures its report in a different way, emphasizing different areas.

"We looked really hard at that," Watts says, "and partnered with each of them to come up with a general purpose risk score that meant the same thing and worked on the same scale for each bureau." As a result, a FICO score based on an Experian report will be slightly different from one based on a Trans Union or Equifax report. Lenders, however, know what those differences are and what they translate into in terms of how likely a person is to miss a payment.

FICO scores are based on 23 factors grouped into five distinct categories that are weighed, measured and balanced in an algorithm-an intricate mathematical formula known only to Fair Isaac Corp. Watts says that each of those five categories has a different value. A "perfect" score would be 800. Lenders prefer to deal with people in the upper-middle and high 700s, and having a score in that range would likely make you eligible for the best mortgage rates available. You can buy a copy of your own credit report and the FICO score it is given by signing on to www.myFICO.com. Once there you can buy a report from any one of the credit reporting agencies, or get all three.

The most important category, the one that counts for 35 percent of the final score, is based on credit history. The question it answers is: How has the person paid bills in the past? The equation includes both positive and negative information. You gain points for not having missed any payments and lose them if you have missed some. It also measures the differences between being merely late, missing a payment or having something repossessed. Next is how much you owe, and this is worth 30 percent of the final score. Credit reporting agencies do not know how much people make or what assets they have. "Instead, we measure debt against their credit limit. A $20,000 debt load measured against $20,000 credit limit will score lower than a $20,000 debt load against a $100,000 credit limit.

"There is a myth," Watts adds, "that the amount of available credit you are not using has a negative effect. Not true. If you are maxed out on three credit cards we will pay attention to that. How you handle money is much more indicative of what you will do than what your credit limit is."

The third area-worth 15 percent-is the length of a person's credit history, and it is an average. If you have had one account for 20 years (240 months) and five other accounts for one year each (5 times 12 months) the months would total 300 divided by six credit accounts for an average age of 50 months or four years and two months. The last two categories are each worth 10 points. The first is the mix of credit accounts. "What we are looking for is experience managing different kinds of credit. Having credit cards is good. An installment loan, like a car, is good. And a personal loan is good. We are looking for dimension or depth to one's credit experience."

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