There are certain things most people know about credit scores. For instance, with better credit, you can get a lower interest rate on things like a mortgage or car loan, and are more likely to qualify for the best credit cards. However, there are some little-known facts about credit scores that you should know -- for example, do you know the five categories of information that make up your score? Here's this information, and four other useful facts about credit scores that our contributors want you to know.
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Sean Williams: Perhaps the most taboo aspect of our credit scores is that few people are aware of how they're actually calculated. Consumers have some idea of what goes into calculating their scores, but without a decent understanding of what aspects are important and carry the greatest weight, it can be difficult to maintain or improve them.
Although FICO is pretty secretive with its magic formula, CreditCards.com was able to lay out a rough outline of what's most important. Not surprisingly, your payment history tops the list, and accounts for an estimated 35% of your credit score. Your payment history is the roadmap that tells lenders whether you can own up to your obligations, and it's an important tool that will help determine what sort of lending rate you'll qualify for.
The next most important tool is your credit utilization, which accounts for about 30% of your credit score. Credit utilization is simply a measure of how much of your available credit you're using. If you're maxing out your credit cards, or carry high balances, then you could carry a higher risk for default, or simply be viewed as an irresponsible spender in the eyes of a lender.
The final three components are length of credit history (15%), credit mix (10%), and new credit accounts (10%). As with your payment history, the longer period of time you can demonstrate good standing with a lender, the better your chances of landing a loan or favorable interest rate. Likewise, lenders like to see a good mix of accounts, ranging from short-term revolving accounts like a store department card to major obligations like a mortgage. It demonstrates you can handle all types of loans.
Lastly, opening up new accounts can "ding" your credit score. The more major inquiries into your credit history over a short period of time, the more it can hurt.
Matt Frankel: It's common knowledge that when you apply for new credit, your application, or "credit inquiry" gets reported to the credit bureaus. And too many inquiries in a short amount of time can damage your score. For example, I applied for a mortgage and two credit cards within a short time period not long ago, and my FICO score dropped about 10 points just because of these inquiries.
This is certainly something to keep in mind, but most people don't know that there's a rate-shopping provision in the FICO formula. Specifically, if you apply for a mortgage or auto loan with several different lenders within a "normal shopping period" -- which ranges from 14 to 45 days, depending on the version of the FICO formula -- it will count as a single inquiry for credit-scoring purpose. In other words, it doesn't matter whether you apply for two mortgages or 20. It will count the same.
The purpose of this is to encourage consumers to shop around for the best interest rates. Even a seemingly tiny difference in mortgage rates can save you thousands of dollars in interest over the life of a 30-year mortgage, so it's definitely worth doing -- especially because rate shopping won't hurt your credit.
Dan Caplinger: Couples getting married have to go through a number of financial surprises. One of the things that many married couples don't realize is that when it comes time to get a major loan such as a home mortgage, they could face a big problem if one person has a low credit score.
In general, banks that lend money for mortgages or other loans take a look at the credit histories of everyone whose name is on the loan application. For married couples, that means that the bank will pull both spouses' credit reports, and it will look at both credit scores.
After marriage, each spouse maintains his or her own credit score, but banks will generally want the assurance of both spouses having solid credit histories in order to meet their requirements. Even if one spouse's credit history is spotless, problems with the other spouse's credit score can trigger higher rates, or even an outright rejection on a mortgage loan.
It's therefore important to identify differences between spouses' credit scores early on, and work to improve the lower-scoring spouse's credit as quickly as possible. That way, you can avoid the unpleasant situation of not being able to get the financing you need down the line.
Jason Hall: Many people think that it's good to carry a balance on your credit cards. And while that's true to some extent, it's really more about showing a history of using and regularly paying off debts.
The reality is, credit utilization can have a big impact on your score from month to month. According to Fair Isaac Corporation,which owns the FICO credit-scoring system that's the dominant-scoring method used in the U.S., 30% of your credit score is based on how much you owe. And the more you owe as a percentage of your available credit -- your credit utilization -- the more it can lower your credit score.
Here's an example: Let's say you're planning a big family vacation and you charge thousands of dollars in airfare, hotels, and rental cars all at one time. There's a good chance your credit score will fall the following month, even if you pay the balance in full. If the balance is reported before you pay it off, your credit utilization will go up, and your score will almost definitely go down.
This is precisely why your mortgage professional doesn't want you to make any major purchases or open new credit accounts if you're in the process of buying a home or refinancing. For day-to-day things, it doesn't really matter. But if you're planning on making a major credit move, such as applying for a home loan in the near future, be aware how your credit-card usage can impact your score in the short term.
The article 4 Things You Never Knew About Credit Scores originally appeared on Fool.com.
Dan Caplinger has no position in any stocks mentioned. Jason Hall has no position in any stocks mentioned. Matthew Frankel has no position in any stocks mentioned. Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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