Like most adult Americans, you’ve probably heard people talk about credit scores. You know it’s good when they are high and bad when they are low and that they have an important bearing on your financial situation. But what is a credit score really, and how is it calculated?
A credit score is a three-digit number that reflects a combination of various financial information. Think of it like a GPA in school – it’s a cumulative value that compares you to other people who also participate in the economy by making purchases and paying bills. (Note that a credit report is a separate thing from a credit score; the report simply tracks your payment history and does not compare you to other people.) There are various ways to calculate a credit score, but the most common one was developed by the Fair Isaac Corporation (FICO), and these days the terms “FICO score” and “credit score” are often used interchangeably.
FICO and other companies are protective of the specifics they use to for calculation, but FICO admits they look at five main categories and assign them different weights in order to determine your overall credit score:
The payment history component examines how well you have met obligations on current and previous credit accounts, as well as taking into account derogatory marks, which include problems such as collections, delinquency, foreclosure, and bankruptcy. Derogatory marks usually affect you for seven to ten years, although they are not the be-all and end-all of good or bad credit. The amount owed refers to how much debt you currently have with lenders as a “utilization ratio” – essentially noting how close you are to maxing out your various lines of credit. The length of credit history looks at how long ago you opened various accounts, as well as how long it’s been since you last used them. New credit refers to how many lines of credit you have opened lately (which is why it’s not a good idea to open several new accounts at once – it makes you look desperate for credit, which makes lenders nervous). The final factor examines how many different types of credit you’re maintaining, such as credit cards, mortgages, student loans, and car loans. If you can successfully balance several different types of credit, you’re probably doing pretty well financially.
Obviously, your credit score tells a potential lender a lot about you and helps inform their decision about whether or not they should trust you with their money. If you’re not keeping up with current payments, you’re close to maxing out several sources of credit, or you suddenly seem desperate for financing opportunities, lenders are going to assume you’ll have trouble paying them back on time or at all. However, if you’ve managed to keep your payments current and mostly live within your means, lenders will see you as a lesser risk. FICO scores can range from 300 to 850; if your score is 740 or higher, that’s considered excellent, and you’ll probably receive the best possible interest rates on any loans. If your score is below 650, however, your interest rates will probably be very high, if you are actually able to qualify for loans.
A major benefit of using your entitlement to secure a VA loan is that the VA’s guarantee of your mortgage gives lenders a greater sense of comfort even if your credit score isn’t that great. You’re also likely to be eligible for lower interest rates than other people with your same credit score who are seeking conventional loans. And once you’re able to obtain a VA home loan and make regular payments on it, your credit score will improve, which will help you the next time you need to open a credit card or take out a car loan. (Just be sure to let enough time pass between applying for new loans and/or credit cards for your credit to actually change.)
If you have any questions about credit and the VA loan process, Fortress VA Loans is here to help. And if you’re ready to put your credit score to use and obtain a loan to purchase, build, or refurbish your dream home, our family of VA loan specialists and lenders can help you get started right away.