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What is a Credit Score?
Before deciding what terms they will offer you, lenders want to know two things about you: both your ability and your willingness to pay back the loan. For the first, they look at your debt-to-income ratio, which is the total of your monthly debt payments divided by your gross monthly income. For your willingness to pay back the loan, they consult your credit score, which tells how promptly you have paid your debts in the past.
The most widely used credit scores are FICO scores, which were developed by Fair Isaac & Company, Inc. Your FICO score will lie between 350 (high risk) and 850 (very low risk).
Credit scores only consider the information contained in your credit profile. They do not consider your income, savings, down payment amount, or demographic factors like gender, race, nationality or marital status. In fact, the elimination of demographic factors is why the scores were invented in the first place.
"Profiling" was considered a dirty word when FICO scores were invented, just as it is now. Credit scoring was developed as a way to consider only what was relevant to somebody's willingness to repay a loan.
Past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit and number of inquiries are all considered in credit scores. Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your score.
Different portions of your credit history are given different weights in your score. 35 percent of your FICO score is based on your payment history. 30 percent is based on your current level of indebtedness. 15 percent is based on the time your open credit has been in use (ten year old accounts are good, six month old ones aren't as good). Another 15 percent is determined by the type of credit available to you (installment loans such as student loans, car loans, etc. versus revolving accounts like credit cards). The final five percent remaining is based on your pursuit of new credit, commonly referred to in the industry as credit inquiries.
Your credit report must contain at least one account which has been open for six months or more, and at least one account that has been updated in the past six months for you to get a credit score. This ensures that there is enough information in your report to generate an accurate score. If you do not meet the minimum criteria to get a score, you may need to establish a credit history prior to applying for a mortgage.
