Whether you are applying for a mortgage, car, or personal loan, your lender will want to know one number: your credit score. This number has become perhaps the most important for anyone seeking a loan.
There's a reason for this: Your credit score tells lenders precisely what kind of a borrower you've been. Have you been a sloppy user, one who pays bills late or misses payments regularly? Your credit score will show it. On the other hand, have you been a responsible borrower, one who's never paid a credit card bill late or missed a car loan payment? Your credit score will show that, too.
Before applying for any loan, it is essential to understand the basics of your credit score and what it means.
FICO Scoring System
Most lenders today rely on the FICO credit-scoring system. This credit score ranges from a low of 350 to a high of 850. So if you want to borrow money, and you want to borrow it at the lowest possible rate, you'll need a score closer to the higher end than the lower.
What does your FICO score include? According to MyFICO.com, your credit score uses:
- Your payment history.
- How often you miss payments or pay your bills late.
- The amount of debt you owe.
- The length of your credit history.
- The types of credit that you use.
All of these items will impact your credit score. The most important of these factors is your payment history, which FICO says accounts for 35 percent of your credit score. Coming in a close second is the amount of debt you owe, which accounts for 30 percent of your score.
The lesson here? If you want an excellent credit score, you need to pay your bills on time, never miss a payment and pay down as much of your credit card debt as possible.
Of course, other factors will negatively impact your credit score. For example, if you lose a home to foreclosure, you can expect your score to drop by 100 or more points. That foreclosure will remain on your credit report for seven years. If you declare bankruptcy, your score will fall by 100 or more points again. Depending on the type of bankruptcy you file, this will remain on your credit report for seven to 10 years.
What Lenders Want
Though it varies by lender, most lenders keep their lowest interest rates for those borrowers whose FICO credit score is 740 or higher. That is considered an excellent score by most lenders.
If your credit score falls below 640, though, you might struggle to obtain a conventional mortgage loan. That is because lenders worry that borrowers with such low scores are more likely to miss payments and default on their loans.
If you want to qualify for today's lowest interest rates, you'll need to bring an excellent credit score to the table. However, if you know you have a low score, it might make more sense to establish a history of paying your bills on time and cutting down on your credit card debt before you borrow again. Then, you can get approvals when applying for your next mortgage, car, or personal loan.