Your ability to qualify for any kind of financing, from auto loans to mortgages, depends on your FICO credit score. Most lenders will pull your credit report looking for just one key piece of information, your FICO score.
The FICO score is used to evaluate your ability to handle a particular line of credit or loan and to also calculate the appropriate interest rate for you. Depending on their institutional financial goals, some lenders may use your highest FICO score. Others will look at the middle score, or in some cases, only one FICO score.
For example, if you were applying for a credit card at a department store, they would run your credit profile (only with your signed permission, of course) and obtain your FICO score. If the store reports to only one of the three credit bureaus, and not all three, then the credit inquiry will only pull from that specific credit bureau. The credit card is either then opened or denied based on only that one specific bureau’s information, and thus uses only one FICO score in it's application process.
The credit system works much differently for mortgage applications. Banks and mortgage lenders report to all three of the credit bureaus (Experian, Equifax and Trans Union if you didn't know), so when you apply for a mortgage they would receive three different FICO scores. These three scores are calculated on the three DIFFERENT credit reports that the credit bureaus send to the lender. Since there are now three different FICO scores, mortgage lenders will only use the middle (or average) FICO score in this instance.
Also, depending on the type of financing you are seeking, whether it is for a new car, a credit card, or a home mortgage, your FICO score makes up a major portion of the decision making process. A lot of lenders will look at nothing more that your score in order to make their decision. Some companies will also flag your file for a recent bankruptcy or forclosure and repossession as well.
Your FICO score is really a "how well I pay my bills score" that consists of the following keys:
35% of your FICO score is based on your payment history. The key points being frequency of payments (read: whether it was paid on time), and most recent occurrences of non-payment. In other words, all late or completely missed payments will hurt your FICO credit score, but more recently missed payments will have a bigger effect on your score than older ones.
30% of your personal FICO score is based on credit utilization. This is calculated based on the balance of all your credit accounts in relation to the maximum credit lines available. Revolving credit lines (read: credit cards) are the most significant part of this score.
Just these two factors comprise 65% of your credit score! That is why I call it a "how well I pay my bills score".
15% of your FICO score covers your individual credit history. This is based on the number of years your credit has been established (the longer, the better). Having one account for 5 years with consistent payments will look better than 3 accounts all paid off and closed within 6 months.
10% of your FICO score involves what types of credit you have, and the mix of revolving credit inquiries (read: credit card applications). This does not include inquiries with no financial rating (Read: an inquiry from a potential employer).
As I mentioned earlier, there are three different FICO scores developed by the Fair Isaac Company, one from each of the three major credit bureaus. Experian uses the Experian/Fair Isaac Risk Model, Equifax uses Beacon, and Trans Union has something called Empirica. Consumers are likely to have a different score with each individual agency because each credit reporting bureau has its own set of reporting companies and there will be variations in the credit information that is sent in to them.
Your FICO score ranges from 300 to 850 and suggests a general credit profile such as:
FICO score of 720 and above
This is a great FICO score, and it suggests that the risk of you defaulting on your credit is very low. If the lender finds any exceptions in your credit report, they will most likely be waived and set aside. If there are any weaknesses in the underwriting your credit (such as not a very long history), your high FICO credit score compensates for that particualr weakness.
FICO score 660 to 719
This is good FICO score, and suggests that your risk of default is still relatively low. This FICO credit score indicates that your credit history is acceptable and most people fall within this range.
FICO score 620 to 659
This FICO credit score represents a certain amount of risk to the lender. The credit underwriter will more than likely consider you, but will investigate a lot further to check on some details. For example, whether you are self-employed, have a high loan to value ratio, have any cash reserves, or are exceeding normal debt to income ratios.
FICO Scores below 640
Anything below 640 is considered sub-prime. Your risk of default is very high, and you will need to present strong compensating factors to the lender before the underwriter would consider approving a loan. Most mortgage lenders will not approve you for a house without at least a minimum 640 credit score.
FICO score between 619 to 585.
The underwriter will consider approving a loan but that depends on your specific credit issues. You are now in the same class as an applicant with no previous delinquency and lack of sufficient credit history. Mortgage lenders are much more likely to see mortgage delinquencies rise if they loan money to a consumer with a FICO score below 620.
FICO score between 584 to 500
You will have to explain your credit history in writing, and will need to pay off most of your debts to even be considered for approval. The loan underwriter may still consider you an acceptable risk but the high risk factors your credit score presents will have a really high interest rate attached to a much smaller credit line.
FICO score below 500
This is really bad credit. There may be some serious issues outside your control that caused this financial setback, however. There are also some individuals who simply do not care about what happens to their credit score. This does not mean that the world has ended, though. There is still hope and a way to fix your score.
Additional Notes About Your Credit Score:
Your credit report changes each month and your FICO score will change as well. Your FICO credit score does not change drastically from one month to the next month, unless there has been a late payment or a negative report hit your account. While late payments, collections, or bankruptcies can be very damaging to your score, it simply takes time to raise your FICO scores back up. It is a good habit to check your credit report every 6 to 12 months.
Your credit report must contain at least one reporting credit line over a six month period in order for a FICO score to be generated at all. Your credit report must have one credit line that has been updated in the last six months as well. This will ensure that there is enough information overall, and enough recent information, to accurately calculate your FICO score.
Your FICO credit score is meant to be a measure of your creditworthiness to a potential lender. In the mortgage industry, mortgage products and lending terms change constantly. If you manage your credit well, you will certainly qualify for a home purchase loan. In the case of credit cards, your account is reviewed periodically (usually every 6 months), and if you manage your credit well, you will most likely be given higher credit limits and offers to upgrade to a better rewards program.