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How to establish and maintain good credit
By Allison Jensen | May 1, 2008
In the wake of the current mortgage crisis, credit scoring is on the defensive, perhaps unjustly. Why, some are asking, didn’t credit scores predict that so many homeowners would fail to pay their mortgages and wind up in foreclosure? Credit scores are arrived at by inputting about your credit history and behavior into a mathematical model. Those based on the model originated by Fair Isaac and Company are called “FICO” scores and are the ones used by most mortgage lenders. However, credit scores don’t address factors such as loan-to-value or debt-to-income ratios. Those are up to the lender, who must apply sensible underwriting standards. In many instances in the past, they didn’t. And credit scores did identify higher risk individuals, but lenders created programs they thought would compensate for the risk involved. In too many cases, they were wrong.
So to blame credit scores for past mortgage problems doesn’t seem entirely fair. That controversy, notwithstanding, good credit scores are even more vital ever to homebuyers than ever. With the annihilation of the subprime lending market, many buyers with poor credit marks have few places to turn. And those with scores that used to be considered highly acceptable, now must pony up more money up front for their loan. So having the best score possible is a top priority for potential homeborrowers. Fair Isaac describes a FICO score as “an estimate of your credit risk based on a snapshot of your credit report at a particular point in time.” FICO scores range from 300 to 850 (a high score is good). Scores above 720 typically qualify for the best rates. Subprime roughly begins below 650, so every point is crucial.
Fair Isaac has a new version of its scoring system, FICO 08, poised to be rolled out soon. It will refine its approach in a number of areas, but will leave the 300-850 score range intact.
To see how different crent credit scores affect your mortgage rate, there is a chart, updated daily with current mortgage rates, at myFICO.com. There are three major credit reporting agencies, each of which maintains your credit history—Experian, Equifax, and TransUnion—and a separate credit score is generated based on the information at each one. Because each credit agency may haveslightly or even significantly different information, your score can vary from agency to agency. In addition, each of the agencies has also tweaked the FICO program, which can yield different scores even when the information is the same at each agency.
Mortgage lenders generally request scores from all three agencies and look at the middle one. According to Fair Isaac, your credit payment history is responsible for 35% of your FICO score; amounts you owe, 30%; length of your credit history, 15%; applications for new credit, 10%; and types of credit used, 10%. You are entitled to a free credit report from each of the agencies (go to annualcreditreport.com), but that doesn’t entitle you to a free credit score from them; for that you will have to pay. Caution: other sites may offer you a free credit report or score, but it may not be a FICO score and it may subject you to their advertising pitches. you get a free annual credit report from one of the agencies, they will be happy to sell you your score at the same time, but the Experian and Trans-Union scores will not be FICO scores and will have a different scoring range. You will need to go to myFICO.com to purchase FICO scores for them.
Here are a few tips for boosting and maintaining your credit score, courtesy of Fair Isaac:
• Closing unused credit accounts won’t increase your score, in fact it may decrease it by having fewer open accounts. But don’t open new accounts just to increase your available credit; that could also lower your score.
• If you are just starting to establish credit, don’t open a lot of new accounts all at once.
• Credit inquiries can lower your score.
However, FICO scores distinguish between searching for a single loan among several lenders and applying for multiple credit lines. Try to fit your comparison shopping within a twoweek period. Want more information? You can get booklets that provide an overview of credit scoring, including more factors that influence credit scores and tips on improving them at myFICO.com.
Topics: Buyers, Buying a Home, Finance, News |
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May 1st, 2008 at 8:02 am
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May 1st, 2008 at 8:24 am
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May 1st, 2008 at 8:25 am
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