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:
Payment History: This data carries the most weight in the analysis. It makes up 35% of ones score. This is information about a persons payment history, whether it has been on time or not. Scores are lowered for slow payments.
Available Credit Ratio: This is the second highest-weighted factor, making up 30% of the score. The scoring process looks at how much credit has been extended to a person and compares it to how much credit is outstanding at any given moment. Available revolving credit will increase a persons score; closing revolving accounts will lower the score. Paying down outstanding loans regularly without closing them also has a positive affect on your FICO 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 outline should go a long way towards helping the consumer understand how their credit score, and specifically their FICO score, is calculated; it should empower consumers to act wisely, increase their FICO scores, and be rewarded with better terms for their loans.