Today if you were to go any lender to apply for a mortgage loan in Greater Boston, you would find that interest rates are very low (when compared to a few years back). But getting your loan application accepted by the lender for a low rate is tougher. One of the most importance criteria’s which lenders use to analyse mortgage loan applications is the credit score of the applicant.Credit scores are calculated by using different formulas by different organisations and they play a major role in both the acceptance of the loan and the interest rate of the loan. By understanding how they calculate the score, you can make the necessary changes, by which your score will increase.
|image by Wikipedia|
Why the Credit Score?
Lenders assume a large risk by lending money; they seek to lower this risk by separating applications into low risk investments, mid risk investments and high risk investments.Depending on the risk involved, the lender will charge a different interest rate (higher for high risk investments). Since the credit score directly correlates to the chances of you defaulting on the mortgage loan payment i.e. the risk of lending money to you, it allows the lender to easily analyse your application for the risk involved in the transaction.
How is the Credit Score Calculated?
Equifax, TransUnion and Experian are the major credit reporting bureaus present in the US. They collect billions and billions of pieces of information related to the credit of different people and publish them in the form of reports (these reports are sometimes free with a 3rd party service, and sometimes have a fee for you to obtain and view). Depending on the information present in the credit report, different parties will use different methods to calculate your credit score. Some lenders draw from a single bureau, and some average. Lenders will usually use the scores from one of the following:
- FICO: Fair, Issac and Company also known as FICO is a public company which calculates individual credit scores based on the following-
- Payment History:The regular payment of bills in time. (35% weight age in the overall score).
- Amount Owed: The amount of money that you already owe has a 30% weight age.
- Length of Credit History:This has a 15% weight age in the overall score.
- New Credit: Any new source of credit that you may have acquired has a 10% weight age.
- Credit Types Used: Lastly the different types of credit sources used by you will have a 10% weight age.
- Vantage Score: Created by the three big credit bureaus to compete with FICO, Vantage score is also popularly used, it is calculated based on-
- Payment History: Calculated based on the timeliness and consistency of your payments (32% weight age).
- Credit Utilization:It is the debt to credit ratio (23% weight age).
- Credit Balances:The amount of debt which you have, the types of debt which you have (15% weight age).
- Depth of Credit:The length of the credit history which is available (13% weight age).
- Recent Credit: The recent credit sources, and new inquiries present. (10% weight age).
- Credit Available: The amount of credit which can be readily be accessed (7% weight age).
- Proprietary: Besides the above, some large lender organisations have their own proprietary calculation methods which they will use to analyze loan applications.
The importance of your credit score cannot be understated. It is a very important factor which plays a major role in deciding your rates. While a high credit score alone will not guarantee the lowest rate (since other factors come into play as well), it will be worth your while to use the above high level information to maintain a high score. We’ve already been exploring some of the more concrete factors in other blog posts.