The financial world revolves around credit. Whenever you want to make a big purchase, like a home, the lender will pull your credit scores. These scores are factored into a three-digit number that determines whether you’re approved for a loan, your interest rate and your mortgage terms.
To make sure you’re getting the best deal, you should understand how credit scores work before you apply for a loan.
Fair Isaac Corporation
While there are several types of credit scores, most lenders use the credit-scoring model developed by the Fair Isaac Corporation. This credit score, known as the FICO score, is a three-digit number ranging from 300 to 850. Lenders use the score to determine how risky it would be to loan you money. For example, if your credit score is 420, you’re considered a very high-risk applicant and you may struggle to get approved or find good rates. If your credit score is 780, you’re considered a low-risk applicant and you’ll likely get the best rates and terms when you apply for a loan.
The credit bureaus
FICO doesn’t collect information to determine your score. Instead, the information is collected by a credit bureau. The main credit bureaus in Canada are Equifax and TransUnion. Each credit bureau collects information about your financial habits and compiles the information into your credit history.
Your credit history stretches back seven years. In some cases, like with a bankruptcy, the history can go back to 10 years. Everything—from your application for a retail store card to whether you pay your bills on time each month—is reported on your credit history.
What goes into your score
To determine your FICO score, information from your credit reports is calculated using a formula. Certain actions are weighted more heavily than others:
- Payment history – 35%
- Debts owed – 30%
- Length of your credit history – 15%
- Types of credit you have – 10%
- Applications for credit – 10%
Know your score
If you’re considering making a large purchase, it is a good idea to pull your credit reports and credit scores several months before you apply for a loan. By law you’re entitled to a free copy of your credit report from each bureau once a year.
You can order your credit scores for a small fee directly through the credit bureaus’ websites. Your credit scores are not included on your free credit reports
Excerpt taken from http://www.realtor.com
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