How does FICO create my credit score?23 Mar Matt Prewett
One of the most common concerns I hear from Home Buyers is fear that their credit score might be significantly lowered by a lender (or multiple lenders) pulling their credit reports. While it’s true that a “hard inquiry” by a lender will affect credit score, understanding how FICO treats credit inquiries can help give better perspective to whether these concerns are relevant.
Credit inquiries can affect credit scores by 1-5 points, mostly depending on how much credit you have (i.e. longevity of credit lines, how many credit lines, etc). Buyers who only recently began opening credit lines are likely to be more negatively affected than those with long-seasoned credit.
FICO treats multiple credit inquiries by mortgage lenders within a 30-day window as only ONE inquiry. They do this because they know it’s a common occurrence for Home Buyers to shop lenders, and it would definitely be detrimental if every credit inquiry lowered credit scores.
It’s also important to understand that if your credit score is above 740, you qualify for the best interest rates for conventional (conforming) loans. If you are below a 620 credit score, a conventional mortgage approval is unlikely, but FHA Financing might still be an option. But the takeaway here is that one credit inquiry by a mortgage lender is more likely to have a significant impact on your ability to qualify for a home loan (or your interest rate) if your credit score is in a range of 620-740.
The most important point to make is this: without a credit inquiry, you can’t begin the mortgage financing approval process. Without a Lender Pre-approval or Pre-Qualification letter, no Seller or Listing Agent will accept your offer on a home. So, having your credit report pulled is a necessary step in the overall Home-Buying process, and in my experience, it should be completed prior to ever looking at homes.
FICO Scores are calculated using many different pieces of credit data in your credit report. This data is grouped into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
What categories are considered when calculating my FICO Score?
Payment history (35%)
The first thing any lender wants to know is whether you've paid past credit accounts on time. This helps a lender figure out the amount of risk it will take on when extending credit. This is the most important factor in a FICO Score.
Be sure to keep your accounts in good standing to build a healthy history.
Amounts owed (30%)
Having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low FICO Score. However, if you are using a lot of your available credit, this may indicate that you are overextended—and banks can interpret this to mean that you are at a higher risk of defaulting.
Length of credit history (15%)
In general, a longer credit history will increase your FICO Scores. However, even people who haven't been using credit for long may have high FICO Scores, depending on how the rest of their credit report looks.
Your FICO Scores take into account:
• How long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average age of all your accounts
• How long specific credit accounts have been established
• How long it has been since you used certain accounts
Credit mix (10%)
FICO Scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. Don't worry, it's not necessary to have one of each.
New credit (10%)
Research shows that opening several credit accounts in a short amount of time represents a greater risk—especially for people who don't have a long credit history. If you can avoid it, try not to open too many accounts too rapidly.
Your FICO Scores consider both positive and negative information in your credit report. Late payments will lower your FICO Scores, but establishing or re-establishing a good track record of making payments on time will raise your credit score.
The importance of credit categories varies by person
Your FICO Scores are unique, just like you. They are calculated based on the five categories referenced above, but for some people, the importance of these categories can be different. For example, scores for people who have not been using credit long will be calculated differently than those with a longer credit history.
In addition, as the information in your credit report changes, so does the evaluation of these factors in determining your FICO Scores.
Your credit report and FICO Scores evolve frequently. Because of this, it's not possible to measure the exact impact of a single factor in how your FICO Score is calculated without looking at your entire report. Even the levels of importance shown in the FICO Scores chart above are for the general population and may be different for different credit profiles.