By Sharon Hassler—Things have changed so much since I was a loan officer years ago before FICO scores became an important part of assessing credit worthiness. Back in the day, if a client had over 3 or 4 credit cards, it could hurt the payment ratio used for mortgage approval.
The potential total balance and payments—not the current amounts—were included in that ratio. That gave the underwriter who reviewed the application an idea of how bad it could be if that borrower maxed out their cards. Sensible? Yes, of course. I often advised my clients to pay off and close credit card accounts to reduce their potential debt so they could get their loan approved. Now if you payoff and close a credit card account, your FICO score drops. Sensible? No, but it benefits the credit card companies. Today checking your credit report doesn't tell you the whole story; you need your FICO score, too. Here's some info on FICO.
The abbreviation "FICO" comes from Fair, Isaac and Company. That organization (now renamed Fair Isaac Corporation) was founded in 1956 by engineer Bill Fair and mathematician Earl Isaac, on the principle that data, used intelligently, can improve business decisions. Along with many other risk/behavior systems and software developed over the years came credit scoring. They introduced the first Fair Isaac credit bureau risk score in 1981. Today FICO® is the standard system used by credit bureaus to report scores; the FICO® score is the standard measure used by lenders to evaluate how likely it is that the borrower will repay the loan.
Your FICO® score is a number calculated on information in your credit history as maintained by a credit bureau. It's based five factors: timeliness of payments, amount of debt owed, age of account, type of account, and number of recent inquiries for new credit. (The next time you're offered 10% off on a purchase if you open a store credit account, remember that's another "inquiry" ding on your credit report!). A high score indicates you are low risk to a lender and, thus, you may receive a better interest rate. A low score indicates high risk so a lender may charge a higher interest rate or deny your loan. However, keep in mind that lenders look at other criteria than the credit score including your income, your employment record and how much and what kind of credit you are seeking. Your credit score can affect not just a home loan but any credit you're requesting, for a car, cell phone, credit card...
When a borrower applies for a loan, the lender will ask permission to order a credit report. The reports come from three credit bureaus—Experian, TransUnion and Equifax—and, since the bureaus obtain different data, their reports and scores generally will not be the same. The lender may order all three credit reports and average the three scores. If you want to try to raise your total FICO® score, it's important to get all three credit reports and compare their content. If you find that the credit bureau reporting the lowest score is missing positive information or shows negative mistakes that could be corrected, work on improving that credit report first.
Thanks to an amendment to the Fair Credit Reporting Act passed by Congress, you can receive a FREE credit report from each of the three credit-reporting bureaus once every 12 months. (The amendment, however, does NOT allow you to get your FICO® score for free, and that score is very important to lenders.) For details and to request a free credit report, visit www.annualcreditreport.com. Or you can contact each of the three credit-reporting bureaus individually:
To save time, you can order all three credit reports and FICO® scores for a small fee. One choice is MyFICO.com where you'll also find more info on improving your credit and FICO® scores.
Contact the credit bureau (see toll-free phones above) for instructions on requesting corrections to your report. You will need to send your request in writing along with any proof you have to document the mistake. You can also ask for comments to be added to your report, such as a valid explanation of why you were late on a payment.
Your score can change every day, any time new information is reported to one of the credit bureaus. Besides updates, the simple passing of time can affect your score, too, and that could be a good thing. The older any late payments, bankruptcies, repossessions or foreclosures are, the better your score.
Computer-based scoring models are applied to data in the credit report, resulting in points for five different factors: payment history, amounts owed, length of credit history, number of new credit accounts opened, and types of credit used. As they say, it's complicated.
Scores range from 300 to 850 with most falling in the middle range. Usually a score must be above 620 to be considered decent. The following is how most lenders look at FICO® scores:
When a lender receives a credit score, the report usually includes from one to four "score reason codes." These codes provide information about why the score was not higher. Lenders can share that information with you. The score reasons are more useful to you than the scores themselves because they shed light on what problems exist in your credit history, including possible errors that need to be corrected in the report. The top 10 most frequently given score reason codes are: