Your buying and refinancing potential rise and fall with the numbers. But, knowing which figures to reach for and the impact of a few points seems fodder for rocket scientists. Let’s break the information down into understandable jargon to make clear the impact these three-digit scores have on you.
What is a Credit Score?
Simply put, a credit score tells a lender your level of trustworthiness in carrying debt. In other words, this figure represents your capacity and willingness to pay on a mortgage or other loan. Conversely, this numerical expression informs banks of your risk of defaulting, not paying on a loan.
After all, the goal of the loan assessment process is to ensure the best outcomes for both you and the lender. In other words, the bank does its best to assess if you can handle the loan. Unfortunately, if you are unable to manage a given loan amount with its accompanying interest rate, no one benefits.
Your credit score comes from an analysis of your credit files. By looking at your previous interactions with loan, credit card and bill payments, a lender gets a numerical picture of your habits, patterns and outstanding debt. This information reveals the likely impact of these factors on repayment of future monies borrowed.
Where Do Credit Scores Come From?
In the U.S., the primary source of credit scores falls in the hands of Equifax, Experian and TransUnion. Your credit files at each of these national credit bureaus informs the Fair, Isaac, and Company (FICO) formula to determine your score. With each agency potentially reporting different information to FICO, credit scores may vary between the bureaus.
While details of the credit score formula remain privileged information, a credit score is generally based on the following factors:
- Payment history
- Debt burden
- Length of credit history
- Types of credit used
- Recent credit inquiries
Also, in the U.S., you are entitled to a free, personal credit report copy from each of the three credit bureaus every year. The Fair and Accurate Credit Transactions Act (FACT Act) ensures this individual report to each resident though credit scores are not included. The value in this report is that it allows you to check for inconsistencies or errors which need to be addressed. Credit scores can be purchased directly from FICO or the national credit bureaus.
What Do Lenders Want in a Credit Scores?
Varying FICO credit ranges exist depending on the use of the score. For instance, auto and bankcard FICO scores offer a slightly greater range than classic or mortgage scores. In regard to mortgages, credit scores range from 300 to 850.
But, what does this mean to you as the borrower? What are lenders looking for?
First, the higher the number, the better. Less risk for banks (and, for you) comes in the form of credit scores toward the top of the range. In general, the breakdown looks like this:
- 750+ Excellent Credit
- 700-749 Good Credit
- 650-699 Fair Credit
- 600-649 Poor Credit
- less than 600 Bad Credit
However, lenders define the ranges which they are comfortable approving. Therefore, some banks require only a 680 or above while others will ask for higher credit scores before granting a loan. Interestingly, in April 2015, the average FICO score was 695.
Also, keep in mind that credit score is only one factor lenders consider. Your income, assets and debt load play into the decision as well. Again, the goal is to increase the chance of successful payment to the benefit of you and the bank.
What Impact Does This Score Have on Rates?
The math is fairly simple. Better credit scores equate to lower interest rates and less specific loan conditions. In other words, higher scores offer you more freedom and greater options in the type of loan for which you can get approved.
According to BankRate, credit scores over 740 generally garner the lowest mortgage interest rates. On the other contrary, scores under 620 make loan approval itself difficult though not impossible. Keep in mind that advertised rates represent the average. Obtaining rates above or below the average depends on your credit score.
Higher credit scores and lower interest rates mean a lower mortgage payment to you, the buyer. Loan savings calculators such as the one at MyFICO.com allow you to see the impact of your credit score on your mortgage. Visit them to get a picture of how slight changes in your score affect your rates.
Leave the complicated formulas and math to FICO and credit bureaus. The underlying concept encourages you to take action to raise your credit scores to reduce interest rates. After all, this three-digit number is your first impression to lenders.