Home : How Credit Scoring Works

How Credit Scoring Works

Posted by Brett Carman on 12/17/2008 at 10:55 AM
Posted in Financial planning

In the current credit crunch, many investors and individuals are wondering how credit scoring works. What does it take credit qualify to borrow money at the most favorable terms? It a little known secret that now basically ALL lenders use “risk-based pricing” or “tiers” when determining what interest rate to offer. The methodology behind this is to fairly compensate lenders for the risk they are taking by lending money.

What is unclear to most everyone is how credit scoring works and I think it would be nice to have a bit more transparency from the “BUREAUS”. I have discovered that there are 5 ways a person’s credit score is derived and roughly how each are weighted. Understanding this will help us all maximize our credit scores in order to most effectively leverage (finance) our real estate purchases.

35% - Payment History
30% - Amounts Owed/Balances
15% - Length of Credit History
10% - Types of Credit
10% - New Credit Inquiries/Accounts

Now more than ever, every FICO point matters and keeping our scores maximized will allow us to potentially save thousands of dollars in interest over our lifetimes. For example, with Fannie Mae or Freddie Mac backed financing, a borrower will pay over ½% more in rate if they put 20% down and have a 719 credit score rather than a 720.

My advice is to be vigilant in your participation of activities which may lower your scores and beware of too many inquiries. It is said that inquiries can cost you 3-5 points each time your report is pulled.

Are any of my readers concerned about the powers being vested to the credit bureaus?

Related Training:
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Brett Carman is a seasoned veteran in the real estate industry for over 17 years. He holds active licenses in real estate, mortgage finance, and property & casualty insurance. Offering a one-stop shop for his residential and commercial clients, he strives to not only educate, but streamline the real estate acquisition process. With a long and proven track record of success, he is uniquely qualified and has a passion for helping people achieve their goals in real estate.

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12 Comments

Posted by Joshua Kundert Consulting on 12/17/2008 11:35 AM

so do you get the same hit in points if you pay for a yearly services to monitor your credit report, the reason i ask is if you don't then maybe lenders should start giving the person wanting a loan the opportunity to provide their own credit report, that would atleast save the dings from credit reporting pulls.

Posted by Cheryle on 12/17/2008 1:19 PM

I think the credit bureaus have too much control in the lending process. There are thousands of people who had a good credit score that kept applying for new credit cards then were unable to pay for them when the economy started to decline.

There are honest people who don't spend more than they can afford, but can't get enough credit for a major purchase like a house because their income is too low. They have credit cards they pay on and never miss a payment but $1,500.00 in credit won't get them too far.

Crooks prosper in our country and too many just change the name of their business or merge with another one and the "stealing" starts all over again. Borrowing credit scores from someone else keeps a lot of dishonest people living quite nicely.

There has to be a better system. Any ideas?

Posted by member1900871 on 12/17/2008 1:57 PM

Yep...I'm concerned about credit bureau's as well. It bothers me that your report being pulled hits your credit score because there are perfectly valid reasons to do it - such as shopping around for the best priced mortgage. Many of them will require to pull your credit before committing to any rate. By penalizing people who shop around they're creating inefficiency in the market.

Posted by Brett Carman

on 12/18/2008 12:03 AM

@Joshua

I appreciate your comments and as a lender, I can say that I already use your suggested approach when prequalifying my clients. It protects their scores from the inquiry deduction of the 3-5 points and also saves us money in the meantime. When we come to terms on a loan and are within 30 days of a closing, I will them pull the credit.

Posted by Brett Carman

on 12/18/2008 12:21 AM

@member1900871
I have suggested in the past that the "systems" allow for some small number of inquiries for "free" each month with no deductions to your scores. This could differentiate between people who pull their credit for day to day life occurences and those the bureaus feel are "struggling" to find credit.

Posted by user41859 on 12/18/2008 9:03 AM

As somebody that has seen his income slashed from 100,000 to 27,000 for the last 6 years and writes about what we are doing to the rest of us every day at http://www.KeepAmericaAtWork.com I do have concerns about the viability of a credit scoring system going into the future, or the accuracy of one.

If 40 to 80 million of us lose our homes, or income property due to the current economy, this is going to jeopardize a substantial amount of peoples scores and its going to make it virtually impossible for 25 to 50 % of America to pick themselves back up by investing in real estate in the future.

Virgil
http://www.KeepAmericaAtWork.com

Posted by Rachael Sutton #1253595 on 12/18/2008 8:27 PM

Absolutely I'm concerned about that. I'm concerned that they can increase interest rates if a payment is delayed or maximum balance is exceeded. I'm concerned that they can deny you credit if you have ever had to have a special arrangement due to illness or accident - even if you paid it off as agreed. I'm concerned that with the present technology they can freeze all transaction approval at stores for your checking account, and credit cards based on collection history. I think what gets me most though is when I was little, everyone said loan sharking was bad and it was illegal. As I understood it, that was when people loaned money to desparate citizens and then charged high interest rates in return. So what is the difference between that and the check advance places and credit cards with a 19-24% interest rate? What loophole makes that OK?

Posted by member1904090 on 01/04/2009 5:00 PM

Hello Mr. Trump,

Thanks for the opportunity to comment. I recently pulled up a credit score of 571 and I'd like to increase it to the mid 600's if possible? A little disappointed that it wasn't higher, but I can understand that once illness sets in, I lost my job, and have been unemployed now for 6 years due to kidney failure and am now on dialysis.

I have decided to return back to work part-time if I can locate a good job, and hopefully pay off the three top bills I couldn't pay when I lost my job, Wells Fargo (where they repossed my automobile because I was unable to pay), Capitol One MC for the same reason, and get my student loan payments back on track.

My question to you is how does one build up the credit score with these issues? Still on dialysis,awaiting a kidney transplant, but just have been unable to locate a good job right now. Forced to retire when I became ill from State government in California after they found out that I was on dialysis.

Any suggestions from you would be great!

Posted by member1904628 on 01/05/2009 9:06 PM

Thanks for the oportunity. Excuse my english please, and I isue a comment not directely related only I want to comment an idea: I considere that one of the foot of the finance system is the "bienes y raices", it is something natural in all the human history the need to have a place, and this foot must be ok to everything works. I think if it is necessary a life time to get a home (30 years,..), You really will not get it, and if "the homes" is one of the feet of our finance system and there is not donig the exchange !!, because you will get at the moment you will die, or go to the same place with other old people, the table is going to fell down. I thing it is important to stablish a finance system that permit to a family get a home in a regular time (10 or 15 years, .. I don´t know), according the salaries, the characteristics of the house, etc.
The exchanges of goods and services, the finance system, is something that will stay with us for our life time, for the human race life time. I considere it something that talk about us, The finance system probably is connect with the idea of God about us in our time of life on the e arth and universe. I think is something that touch God.

Posted by credit repair ideas on 07/25/2009 6:12 AM

With the credit crunch in full effect it's now more important than ever to work on improving your credit scores. Most people don't realize how important a good credit score is until they are denied for a loan or offered high interest rate loans which costs them thousands. There are (2) major things you can do to raise your score quickly which is eliminating the negatives from your credit reports as well as adding positive tradelines (or credit lines) to your reports. My sister went from the low 500's to over 670 in 4 months using a combination of the 2 things mentioned above. She used this company www.thecreditbar.com to assist in navigating the maze and it paid off handsomely.

Posted by member11000083 on 08/04/2009 9:42 PM

This is a tough one if you are acquiring and improving property. Credit inquiries are part of carrying on business. We are an apartment owner who is actively acquiring and improving properties and it seems like we are continually submitting a new credit application.

Blake Ratcliff
The Apartment Guy
www.apartmentmarketingsolutions.com

Posted by credit repair ideas on 09/16/2009 7:27 AM

With the credit crunch in full effect it's now more important than ever to work on improving your credit scores. Most people don't realize how important a good credit score is until they are denied for a loan or offered high interest rate loans which costs them thousands. There are (2) major things you can do to raise your score quickly which is eliminating the negatives from your credit reports as well as adding positive tradelines (or credit lines) to your reports. My sister went from the low 500's to over 670 in 4 months using a combination of the 2 things mentioned above. She used this company <a href="http://www.thecreditbar.com">www.thecreditbar.com</a... to assist in navigating the maze and it paid off handsomely.

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