Economists' Outlook

Housing stats and analysis from NAR's research experts.

What Does Your Credit Score Mean?

In a previous blog, I discussed the importance of financial literacy education as a crucial tool for helping young adults become future homeowners and increase their economic well-being over time. In this blog, I will discuss how one’s credit score can affect the ability to obtain loans, and the cost of those loans.

A credit score significantly determines the terms of your loans and whether you can afford these loans or not. Credit scores are used in evaluating a range of loans such as personal loans, car loans, and home mortgages, so credit scores are equally important for both renters and homeowners.

Your credit score will determine how much you can borrow and the length of your repayment. The higher the credit score, the better the rate on your loan, and the lower the monthly payment.

Because a credit score is a critical determinant of your ability to secure a loan at a low rate, it is important to understand what factors determine your credit score. Knowing what determines your credit score will then help you plan for and work towards improving your credit score. This is all part gaining financial literacy.

Factors Affecting FICO Credit Score

FICO scores range from 300 to 850 with the higher number being the better score and the lower figure representing a higher risk for the loan. When you take a loan, the bank has to assess the possibility of repayment and determine the risk for the loan. Factors that affect the scores are credit card debt, student loan debt, payment history, bankruptcy and foreclosures. Personal or demographic information such as age, race, address, marital status, income and employment do not affect credit scores. Typically, Equifax, Experian, and Transunion run your score and of the three scores, the middle score is what consumers go by.

Data from your credit report goes into five major categories that make up a FICO score. The scoring model evaluates some factors more heavily, such as debt owed and payment history.

Payment history: (35 percent) -- Your account payment information, including any delinquencies and public records. Your ability to make payments on time.

Amounts owed: (30 percent) -- How much you owe on your accounts. The amount of available credit you are using on revolving accounts is heavily weighted.

Length of credit history: (15 percent) -- How long ago you opened accounts and time since account opened.

Types of credit used: (10 percent) -- The mix of accounts you have, such as revolving and installment. This would include credit card debt as well as student loans or mortgage payments.

New credit: (10 percent) -- Your pursuit of new credit, including credit inquiries and number of recently opened accounts. This includes secured and unsecured credit cards.

The Urban Institute provides a monthly chart book on housing finance. This chart shows Fannie Mae’s loan level price adjustments LLPAs, which are, expressed as upfront charges. The higher the credit score the lower percentage of the charge assessed. A higher loan-to-value will increase the percentage of payment but we can see the impact of the lower credit score pushing up the charges assessed. “Simply put, LLPAs are added charges for certain risk factors on a mortgage. They are high loan-to-value (LTV), low credit scores, cash out, investment property, etc. They are calculated and assessed as a percentage of the loan amount. For example, if the loan amount is $100,000 and the total LLPAs equals 0.25%, the charge would equal $250.” Posted by the mortgage calculator.

Improvements in the Credit Score Models

It would be significant to consumers if monthly rent payments and utilities were included in their FICO scores. Many renters may be paying these bills in a timely fashion but they would not appear on your credit report. While some credit agencies may have rent payments as a part of their credit scores, there is no guarantee they are included in the scoring figure because rent data is not standardized. However adding that to the credit reports seems to be the trend moving forward.

The Vantage score 3.0 is a newer model used to run credit reports. This newer system is supposed to have a more consistent credit-scoring model. The Vantage system is helpful to those who do not have much, or have very little credit history. The most recent Vantage system is the 4.0 system, which is supposed to give lenders a deeper look into a consumer’s credit history. It also does not hold consumers to the usual standard of FICO scores giving them some leniency on medical accounts and tax liens for example. For mortgage, underwriting lenders Fannie and Freddie are more likely to use traditional FICO scores.

How to Improve Your Credit Score

Paying off credit cards in a timely fashion as well as paying more than the monthly minimum is helpful. Some consumers apply for 0% annual percentage yield (APR) balance transfers to save money on interest paid over that period. Those who have credit card debt not only want to maintain their monthly payments on time but they also want to make sure they are not using more than 20-30% of the credit line limit. Some financial consultants recommend using even less between 10-20%, which would benefit your credit score and reduce your monthly payments based on your APR.

Keeping track of your debt is paramount. One can pay down the debt as well. Some consumers are using tax returns to pay down debt.

Paying your school loans on time will also be beneficial for your credit scores. Most consumers who have student loans also are likely to have new lines of credit and still trying to establish credit. School loans make up a large portion of debt held by many Americans. Based on NAR 2017 Student Loan Debt and Housing survey data, in some instances, debt levels can reach over $100,000, which would take decades to pay back. Based also on NAR survey data, 32 percent of respondents from a national sample indicated that they defaulted or forbore on their student loans. This would not help to increase and improve your credit score.

Look at this article also on how to improve your credit score

You can also check your credit scores free annually so knowing your score is helpful for how you plan your future moves. While some states may have higher credit scores than others, credit scores are driven by individuals and depend on several factors. Some of those factors are income, where you live, poverty levels, and financial literacy. Being on top of your credit will keep you prepared for future financial decisions. Some consumers turn to credit repair resources such as LAJ Financial Solutions, Credit Saint, or Lexington Law, that can help remove blemishes from your credit report. Also learning how to leverage your credit will expand consumer’s options on future investments and strategies. Some homeowners can leverage their credit to obtain a FHA or VA loan to get a secondary mortgage.