Why Your FICO Score Is All Important
The most common credit score used by mortgage lenders in the United States is the FICO score. This score helps lenders determine a loan applicants creditworthiness and has a direct bearing on the terms that the lender is likely to offer any given individual. Generally speaking, the higher the FICO score, the lower the risk. This means that people with higher scores usually receive more favorable loan terms.
How a FICO score is calculated is a proprietary industry secret held in the strictest confidence. However, the FICO corporation has made available a general outline of what information they use in the credit scoring process. Knowing what makes up a FICO score empowers consumers to raise their scores by handling credit appropriately. Here is a list of the factors used in calculating a FICO score, including how important each kind of information is to the formula:
The most influential factor is ones payment history. This looks at the individuals history of making payments on credit accounts, and lowers the score for each late or missed payment. This factor is weighted at some 35% of ones FICO score.
The second most important factor is the ratio of credit used against the amount of credit available. The best scores come from having a large amount of credit available while only using a small fraction of it. This score is increased by paying down outstanding loans, but without closing the loan. Closing revolving accounts, such as credit cards, lowers this score; while keeping them open but paid down increases it. This factor is weighted at some 30% of a persons credit score.
Length of Credit History: This information counts as 15% of your FICO score. This factor is important because it can shows how a borrower has behaved in the past and is a pretty good indicator of how they will behave in the future. If you have a long credit history your score will be higher, while those just starting out will have a lower score in this area.
Credit Diversity and Credit Inquiries: At 10% each these factors are still an important part of your score to understand. If a consumer has handled diverse kinds of credit appropriately it impacts the FICO score positively. However, if there are many inquiries into a persons credit the score will go down. The number of recent inquiries gives a lender a look at an applicants current financial picture, which is vital information when extending credit.
This overview of how FICO scores are calculated can help and empower consumers as they learn how to take care of and monitor their credit and help them obtain more favorable loan terms.
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