Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
Credit Report and Scores
Jenny meets with her loan officer to discuss her options in purchasing a home. This is Jenny's first home so she's super excited. John, the loan officer, starts by telling Jenny he has bad news: she wasn't approved for a home loan. John says, 'We pulled your credit report and score and there were too many negative factors that led to our decision.' A credit report is a written report of your debt and how well you've paid it. In addition, there's a FICO score, a credit score administered by the Fair Isaac Corporation, which provides a numerical value of several categories that make it easy to determine if you're indeed credit worthy.
For the rest of this lesson, we'll discuss the FICO score and the factors that affect your credit report: history, maximization, time, and composition.
John shows Jenny her FICO score of 590. He tells her if the score would have been at least 600, then the mortgage lender would have approved the loan but with a higher interest rate. Interest is the cost of borrowing money. When a lender believes you're a high-risk, meaning you have a history of paying late, have too much debt, or have no credit history, they may substantially increase the interest rate. However, if you have a score above 700, your interest rate will be much lower, since the risk of you defaulting on the loan is minimal.
Components of a Credit Report
Now let's understand the four main components of your report.
Payment history is how well you pay your credit accounts. Lenders want to see how well you've paid your accounts. Your credit report shows how many times you've been late and how late you've been. Each account shows if you've been 30, 60, 90 or 100+ days late. In Jenny's case, she's been late many times. Payment history comprises 35% of your score.
As John tells Jenny, another factor affecting her score is maximization, or using all of your available credit, because Jenny has maxed out her credit cards. In sum, using credit does not negatively affect your score, however, using all of your available credit will. John explains to Jenny that she has 5 credit cards, each with $1,000 limit for a total of $5,000. The balance on all five credit cards is $4,500, calculating her maximization at 90%. Lenders like to see maximization around 30% or less and maximizing accounts for 30% of your score.
Another important factor is time, or how long you've been using credit. John asks Jenny if she's ever heard the phrase, 'No credit is bad credit'? Jenny shakes her head no and asks him to clarify. John explains: lenders look at how long you've been using credit. If you haven't used credit at all or for a very short time, they cannot determine how well you will pay your bills and, therefore, will assume you're a high credit risk. History accounts for 15% of your score.
Now, let's talk about composition, the types of credit that make up your credit report. There are many different types of credit, such as credit cards, personal loans, and mortgage loans. John tells Jenny most of her report is comprised of credit cards. Of course, a mortgage, which has a higher loan value, will hold more weight. Additionally, Jenny had opened several new accounts in a short period of time, which may show lenders she's in financial trouble and cannot pay cash for everyday expenses. Composition accounts for 20% of the score.
Jenny thanks John for explaining the credit report and score. She will continue to pay her bills on time, and hopefully, her score will increase to qualify her for a home loan in the future.
A credit report is a written report of your debt and how well you've paid it. The most common is the FICO score, a credit score administered by the Fair Isaac Corporation. Knowing the components of your credit score, which are payment history, time, maximization, and composition, is essential in establishing and maintaining good credit. Paying your bills on time, under-utilizing your credit, and ensuring you have a mixture of credit will ensure you maintain an acceptable credit score.
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