What does a low credit score mean?

The importance of a good credit rating really can’t be overstated during the mortgage lending process. While lenders have become more flexible with their loan programs, most still hold the credit rating as one of the key deciding factors in both lending money and determining interest rates. Credit ratings show your overall financial health. When you or a lender receives your FICO score, up to four ‘‘score reasons’’ accompany that score and help explain the top reasons why your score was not higher. According to Fair Isaac & Co., these reasons are more useful than the score itself in helping you determine how you might improve your score over time, and whether your credit report might contain errors. However, if you already have a high score (for example, in the mid-700s or higher) some of the reasons may not be very helpful, as they may reference the factors that have the least impact on your score, such as length of credit history, new credit, and types of credit in use. Here are the top ten most frequently given score reasons. (Note that the specific wording given by your lender may be different from the reasons shown in this list):

1. Serious delinquency
2. Serious delinquency, and public record or collection filed
3. Derogatory public record or collection filed
4. Time since delinquency too recent or unknown
5. Level of delinquency on accounts
6. Number of accounts with delinquency
7. Amount owed on accounts
8. Proportion of balances to credit limits on revolving accounts too high
9. Length of time accounts have been established
10. Too many accounts with balances

Five Factors that Determine Credit Record

A credit score basically condenses your credit history into a single number, and while the credit bureaus don’t reveal how these scores are computed, the scores themselves are calculated by using scoring models and mathematical tables that assign points for different pieces of information that best predict future credit performance.
Credit scores analyze various aspects of borrowers’ credit history, including:
❑ Late payments
❑ The amount of time credit has been established
❑ The amount of credit used versus the amount of credit available
❑ Length of time at present residence
❑ Employment history
❑ Negative credit information (bankruptcies, credit card charge-offs,
accounts that are in collections)
According to Fair Isaac & Co., the five factors that determine your credit score are:

1. Payment History (approximately 35 percent of your score): The factor that has the biggest impact on your score is whether you have paid past credit accounts on time. However, an overall good credit picture can outweigh a few late payments, and late payments will continue to have less impact over time.
2. Amounts Owed (approximately 30 percent): Having credit accounts and owing money doesn’t mean you are a high-risk borrower. But owing a lot of money on numerous accounts can suggest that you are overextended and more likely to make some payments late or not at all. Part of the science of scoring is determining how much debt is too much for a given credit profile.
3. Length of Credit History (approximately 15 percent): In general, a longer credit history will improve your FICO score. Lenders want to see that you can responsibly manage your available credit over time. However, even people who have not been using credit very long may get high scores, depending on how the rest of their credit report looks.
4. New Credit (approximately 10 percent): People today tend to have more credit and shop for credit more frequently. But opening several credit accounts in a short period of time can represent greater risk—especially for people with short credit histories. Requests for new credit can also represent greater risk. However, FICO scores are able to distinguish between a search for many new credit accounts and rate shopping. FICO scores generally do not associate shopping for the best rate on a loan with higher risk.
5. Types of Credit in Use (approximately 10 percent): Your FICO score will reflect your mix of credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. While a healthy mix will improve your score, it is not necessary to have one of each, and it is not a good idea to open credit accounts you don’t intend to use. The credit mix usually won’t be a key factor in determining your score—but it will be more important if your credit report doesn’t have much other information on which to base a score.

What is a credit report?

Credit ratings are very important to lenders because they show your overall financial health and package it neatly into a multipage report that reads something like a report card from grade school. Credit reports are pretty telling, but they’re also not always 100 percent accurate, so be prepared to deal with any inaccuracies that may come up during the review process. Credit-reporting agencies prepare the reports. There are three reporting agencies and they all have slightly different ways of determining your financial health although they are focused on the same task at hand. The three main reporting agencies are Equifax, Experian, and Trans Union. If you have concerns about your report and what lenders will see on it, it would be wise to order a copy of your credit report (typically for a nominal fee) via phone or on the Web from:
Once you’ve filled out your loan application, the lender will order your ‘‘score,’’ commonly known as a FICO score (for Fair Isaac & Co.), from one or more of the reporting agencies just listed. Lenders also use salary, length of employment, and other factors when making their decision, but the FICO score is one of the first places they look. Some lenders use one of the three scores while others select the ‘‘middle’’ score as a measure.