FICO Credit Score: Understanding How Credit Works
In this second part of a 3 part series we are going to talk about the FICO credit score. In the first part we talked about the pros and cons of credit monitoring. FICO scores are critical to your ability to get a new credit card, car loan, or home, so let’s take a quick look at what impacts these scores and some things to keep in mind on how to increase your FICO credit score.
What Goes into My FICO Score?
There are multiple things that go into your FICO score, including:
- New Credit – 10%
- Amount Owed – 30%
- Length of Credit History – 15%
- Payment History – 35%
- Credit Mix – 10%
Now, let’s look a little deeper into each of these.
New Credit – 10%
New credit doesn’t necessarily have a bad impact on your FICO score. For example, if you get a car loan that is an installment debt and you start making payments on it, it’s not going to impact your credit.
However, say you get a revolving credit account with $1,000 in high credit and an immediate balance of $1,000. When it comes to your score, the algorithm that is used may think that you are desperate for credit and may not be an acceptable credit risk. In other words, this may lead to a lower score.
Amount Owed – 30%
Since we’re speaking about revolving debts, let’s say you have three credit cards at high credit, one at $1,000 with a $1,000 balance, one at $2,000 with a $2,000 balance, and one at a $2,500 with a $2,500 balance.
This will have a very negative impact on your FICO score. It will also impact your ability to make it through the automated underwriting systems.
If we want to really look closely at these things, say on those same three credit cards, the balances are now $500, $750, and $1,000, which is less than 50% of your high credit. This, unlike the other examples, will reflect well on your FICO score. It shows that you have a great ability to manage your use of your revolving credit debts.
Length of Credit History – 15%
The longest time period that we see in a lot of accounts on credit reports is 99 months, which is a long time in the credit world.
Let’s look at some key lengths of credit history:
- 6 months
- 12 months
- 24 months
When you make a certain number of payments, you will see your credit score go up:
- 6 months – 7th payment
- 12 months – 13th payment
- 24 months – 25th payment
When you get to the 7th and 13th payments, you’ll get an increase to your credit score. Then, when you get to the 25th payment, your credit has matured because you have a long payment history.
When it comes to revolving credit, like with a credit card, how many payments you’ve made has less of a factor. Instead, FICO looks at the utilization percentage of your credit card balance. As you pay down that balance, your debt-to-income ratio decreases, which has a positive effect on your credit rating.
Payment History – 35%
If you’ve had a late payment on your credit file, that doesn’t mean you won’t qualify for a VA loan.
One of the things we pride ourselves in here at Low VA Rates is that we look at the veteran’s entire picture. We strive to structure home loans for each client to be able to obtain a house with their VA home loan benefits, and to make sure that they’ll be able to retain that home.
So if you have a payment that is 30 days or more overdue, this is considered a minor derogatory payment. If you have a payment that is 90 days or more overdue, this is considered a major derogatory payment.
Your payment history is directly linked to the length of credit history. So, if you have a brand new account that has a late payment, that will have a significant negative impact on your credit score. But if you have a late payment on an account older than 24 months, your credit score will take into consideration the percentage of on-time payments you’ve had. So if you’ve made 30 payments and only one of them was late, it’s probably not going to be too big of a deal.
In addition to the length of credit history, how much a late payment impacts your credit score is also determined by recency. Basically, how long ago did the late payment happen? If you’ve had a late payment in under 6 months, it’s going to have a pretty negative impact. If the late payment occurred more than 12 months ago, the impact is less. And if the last payment happened more than 24 months ago, it will probably have a very minor impact.
Now, one of the things that we do see unique to payment history involves old collection accounts. If you have an old collections account and it’s been there for awhile, time plays a critical role in this situation. You don’t just want to pay it without consulting a lender because that triggers a more recent late payment in your payment history section.
Credit Mix – 10%
Credit mix involves the nature of each account in your credit file.
If your mix includes late payments with lenders that are considered high-risk—such as personal finance loan lenders, check cashing companies, or department stores—it can really impact your FICO score and take your credit down.
Even though, at just 10%, your credit mix doesn’t take up a large portion of your overall FICO score, it’s impact can be significant because of how it interacts with the other areas that make up your credit score.
So, for example, if you have a new finance company account (i.e. a short length of history with a credit mix that includes a high-risk lender) and you’ve missed a payment on it (giving you a negative payment history), plus you’re almost at the max balance on it (another negative, this time in the amount owed category), it becomes the perfect storm of bad news for your FICO score.
A Low FICO Score Is Not the End
We hope this discussion about how your FICO score can impact your ability to get a home loan was helpful.
If you have any further questions about this topic, please call us here at Low VA Rates. We’d love to look at your credit report with you and create a plan to fix your FICO score. That way you can buy a home or refinance your current one using the VA home loan benefits you’ve worked so hard to earn.