The difference between a credit report with a score of 700 and a credit report with a score of 580 could result in a payment of $300 per month or more when purchasing a home of $500,000 or more. If you are like me, then you are undoubtedly curious about how the credit reporting agencies determine credit score. What's even more mystifying to me is that the there major credit reporting agencies: Experian, Equifax and TransUnion access the same credit information and yet the credit reporting agencies typically report different credit scores. The range in the scores can vary substantially. The middle score is generally used when buying a house or applying for credit.
Since we all want a good credit score of 700 or higher it's important to understand a few basics on how to achieve a credit score of 700 or higher ...and maintain it!
There are five basic elements of a credit score. Once we understand what constitutes our credit score we can begin to take the necessary steps to increase our credit score.
- Payment History: Payment History constitutes thirty percent of a credit score. It's important to ensure that all payments are made on time. All payments are reported in this category - current payments and late payments. If you are buying a house it is best to wait until after the close of escrow before paying off a collection debt, judgment or tax lien because it will actually lower your score in the short term. Many lenders however may require certain debts, liens, or judgments be paid as a condition of final loan approval. Late payments within a twelve month period will lower a credit score significantly.
- Outstanding Debt: This category also constitutes thirty percent of a credit score. It also provides an easy way to raise a credit score. Outstanding debt is calculated by dividing the total amount owed by your credit limit. If you have more than one credit card, as many people do, then spread out the credit card debt so that the balance divided by the limit is at 35-50%. Having no credit typically will result in no score. When buying a house, many lenders require four credit lines with one having at least a $2,500 limit.
- Credit History: Credit history is about the age of the accounts. It is best to use older accounts - the more seasoned the credit account - the better provided payments are made on time. If you are buying a house and are in the middle of a home loan process - do not close any accounts because doing so may drop your credit score. Some lenders may require certain accounts be paid off or closed as a condition of approving a loan. The same rule applies to the use of credit. When buying a house be careful to keep spending at a minimum. Some people get excited about buying a house and want new furniture too. This results in large ticket items being charged on credit which may cause the debt to income ratios to shift and ultimately the lender may not fund the loan. If you can afford new furniture wait to make the purchase until after the close of escrow. This category constitutes twenty percent of a credit score.
- New Credit: It is best to have a maximum of four credit cards. If you are buying a house and you are in the middle of the loan process do not apply for new credit - not even with the very attractive zero percent interest credit cards, furniture, electronic or other type of credit that offer temping terms. Credit cards that offer no payments for 12 months or more will definitely lower a credit score. This is so because the credit reporting agencies view this as at your credit limit and this relates back to outstanding debt. Remember outstanding debt constitutes thirty percent of your credit score. Many lenders will check credits scores before they give final approval on a loan. When buying a home resist such temptation during the loan process and wait until escrow closes before saying yes to zero percent, no payments for twelve months credit lines. This category constitutes ten percent of a credit score.
- Types of Credit in Use: This category constitutes ten percent of a credit score. It is good to have a blend of various types of credit such as credit card accounts, vehicle loans and mortgages.
Good credit reporting will remain on your credit report for an indefinite period of time. Generally speaking the rule of 7 applies to the balance of your credit report. For example: a closed account will remain on your credit report for 7 years. If you do not use an account the information will be removed every 7 years. Negative reporting such as late payments will remain on your credit report for 7 years from the date it was reported or from the date an outstanding debt or judgment was paid off. Public records typically remain for 7 years. Bankruptcies remain for 10 years and most inquiries will remain for up to 2 years.
Kathleen Daniels
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