Credit score: What's in your FICO rating?
Your credit score reflects your ability to make loan payments on time and to manage your overall credit, but is used by lenders to determine your likelihood of paying back a loan and keeping current on payments. In most cases, this number is derived using a formula created by the Fair Issac Corporation, which is the reason this score is also known as a FICO score. According to Fair Issac, the median FICO score in the U.S. is 711.
You may have actually asked yourself: "What does my credit score mean?" It may be obvious that your FICO score can affect your likelihood of qualifying for a loan, but it can also impact the interest rate you are offered and the amount you qualify to borrow. Whether you have excellent credit or are considered a sub-prime borrower, knowing how a FICO score can affect your borrowing is important, so here's a quick look at common FICO score ranges:
720 and above
Your credit score is considered excellent, making you eligible for some of the top loan rates. Shopping around should be a priority since lenders know you are likely to make timely repayments and they want you as a borrower. Your high FICO score can come with other advantages. You also might qualify for a home equity loan or line of credit with an interest rate equal to or below the current prime rate or even to obtain a low interest rate, below 10 percent, on a credit card. For 80 percent mortgages, Fannie Mae adds a .25 percent surcharge to mortgage fees for those with scores of 740 or better, and a .5 percent charge for those at 720.
675 to 719
Even if your FICO score drops below a 720, you should still be able to secure a solid loan. The loan may not be at the lender's best rate, but you will likely remain seen as a borrower who can make on-time payments. However, many programs require a 680 credit score for eligibility, so it's worth improving your score before applying for a home loan or other form of credit. Fannie Mae's surcharges for 80 percent loans are 1.00 percent for a 719 score (the difference between 719 and 720 can mean hundreds or even thousands of dollars in loan fees), 1.75 percent for those at 680, and 2.50 percent for applicants with FICOs of 675. That's an extra $5,000 for a $200,000 mortgage!
620 to 674
A FICO score in this range is considered below average and could result in you paying a premium on your loans, especially for unsecured financing like credit cards and personal loans. Fannie Mae loans for people in this range are much harder to get, and the fees are quite high -- an extra 2.5 percent at 675 and a full 3.0 percent for those lower than 660. You may also need to take additional steps to show a lender that you are creditworthy, proving that your credit problems were either not your fault of have at least been resolved. However, once approved for a loan, if you make your payments on time, you could refinance your loan at a later date, leading you to a lower interest rate and money saved over time.
When your FICO score drops below 620, you fall into a category for the "sub-prime" borrower. This does not make it impossible for you to qualify for a loan, but you will have more difficulty securing financing than those with top FICO scores. Indeed, you may qualify for a sub-prime loan with very high rates -- lenders aren't trying to punish you, but they base the rates on the likelihood that someone with your scores will default on the loan. If the "base rate" a lender needs to charge to make a profit is five percent, and four percent of people in the 720 FICO range default on their loans, lenders have to charge a rate of 9.38 percent to make a profit. If 14 percent of those with 620 FICOs default, lenders must charge 22.09 percent interest to make five percent!
Even landlords can access your credit report to determine whether they want you as the next renter to sign a lease. People with good credit are offered lower rates for insurance coverage, and they have less to worry about when they apply for jobs in certain fields -- though several studies have shown that credit scores and job performance are not related, nearly half of all employers still pull credit reports before making job offers. For many reasons it pays to improve your credit scores and to monitor them over time. That's easy to do at LendingTree's Money Center, which offers truly free credit scores and makes it easy to both check your score and see what interest rates you're offered.
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