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Behind the Curtain: Credit Score Factors Revealed

Although credit scores have been in use for decades, the creation and use of such data continues to puzzle many Americans. In fact, a new study shows that 42 percent of all borrowers are unaware that credit scores are used to determine whether or not they can get a mortgage and the rate they will pay.

Credit scores were developed so that creditors of all types, including those who finance cars, credit cards and home loans, would have a way to look at credit reports in an objective manner. Credit score pioneer Fair Isaac Corporation says that credit scores are based on five central factors.

The Five Factors

First, your credit history (35 percent) – that's whether or not you have paid debts in the past in a full and timely basis.

Second, how much you owe (30 percent) is important when creating credit scores. It's not just the dollar amount it's also whether the debt you owe is with revolving accounts such as credit cards or non-revolving accounts such as mortgages.

Third, longevity (15 percent) counts. The longer your credit history better for you in terms of credit scoring. The logic is that there is more data to consider over time and thus less risk.

Fourth, your credit mix (10 percent), the type of credit you use, is important. This is the soup of credit cards, auto debt, home loans, retail accounts and installment financing that you carry.

Fifth, a credit score can be greatly influenced by the sudden addition of new credit (10 percent). Increasing the credit lines that you have or opening new accounts in a short timeframe suggests greater risk to creditors.

Assessing Risk

With VA loans the government does not actually require the use of credit scores. However, the money for VA mortgages comes from lenders and it is lenders who look at credit scores as part of the process of assessing risk.

Because the VA provides strong guarantees to lenders the credit score requirements for VA loans are generally less stringent than with other forms of financing. This happens because the VA wants lenders to look at what is called residual income. The cash money available each month after basic bills have been paid.

The result is that while VA credit score requirements are generally lower when compared with other forms of mortgage borrowing they do impact loan decisions. This makes a new study from the Consumer Federation of America (CFA) and VantageScore Solutions important because it turns out that many borrowers are not sure how credit scores work.

For instance, your age and marital status have no impact on your credit score, yet at least 40 percent of those polled believe such factors are included.

“Low credit scores will often cost car buyers more than $5,000 in additional finance charges and cost home purchasers tens of thousands of dollars in additional mortgage loan costs," says Stephen Brobeck, CFA’s Executive Director, in a article. "And low scores are likely to limit consumer access to, and increase the cost of, services such as cell phone service, electric service and rental housing.”

What can you do to get a better credit score? The survey suggests several important strategies:

  1. Pay bills on time and in full every month.
  2. Don't max out, or come close to maxing out, credit accounts.
  3. Pay down debt rather than just moving it around from account to account.
  4. Avoid quickly opening new accounts.