When you apply for a mortgage, your lender will request a tri-merge (all 3 bureaus) credit report from a credit reporting company. This company pulls together a credit report electronically.
Along with the information, the credit reporting company receives a numerical score. The score represents a composite of your credit history, employment, ability to save, and so on. The most well known of these scores is known as the FICO score, which was a model developed by the Fair-Isaacs Company. Scores can change literally daily, depending on the information received at the repositories.
The Fair-Isaacs Company and the other major credit repositories do not divulge how the scoring model works. Congress is pressuring the credit repositories to be more accountable for the accuracy of the information they report AND to divulge what goes into the scoring models, to help people better understand how to improve their scores.
Why is this important?
The lending industry is moving toward "risk-based" pricing. This means that the higher one's credit scores, the less paper they will have to provide to prove that they are creditworthy AND the interest rate and/or fees a borrower pays will be based on the level of their scores.
This system, while perhaps unfair to some, will be fantastic for those who maintain excellent credit. It's one way that good credit risks can be rewarded.
- Pay all your payments on time.
- Don’t apply for any new credit unnecessarily. Every time you sign and return a new credit card offering, or open an account at a store, an inquiry will be generated and that can reduce your score.
- If you must maintain credit card balances, try to keep them at a level that is 40% - 50% of the maximum credit limit. In other words, if the credit limit is $5,000, try to keep your running balance below $2,000.
- Consolidating all your credit cards can hurt your score as well.
- If you get into a dispute and it isn't a huge amount, pay it and move on. Having one or more collections, even if they are small amounts, can really hurt your score.
There are many more tidbits, but I will save them for the next sections, when I will also discuss how to correct erroneous credit information.
If you have recently obtained your credit report and you are not happy with what was reported, you can take steps to correct the erroneous information on it. There are also proactive things you can do to improve your scores, if you are anticipating applying for a mortgage anytime soon.