We all know that the interest rate we get when taking out a mortgage is based on our credit score but how the lender arrives at that score seems is a bit of a mystery. The score is supposed to help a lender determine the risk involved in lending to the party. The higher the score, theoretically, the lower the risk.
There are three credit reporting agencies - Equifax, Experian, and TransUnion. They collect data on each of us that is fed into a mathematical model that spits out a score. There are several credit score models which explains why you may have a higher credit score when you are shopping for a car than when you are looking at mortgages.
What the reporting agencies look at is basically as follows:
Payment history - 35% of your score
Debt Level - 30% of your score
Length of Credit - 15% of your score
Inquiries (when a lender pulls your score this is called an inquiry) - 10% of your score
Mix of Credit - 10% of your score.
Credit cards have a very high impact on your score. Those without any credit cards will not reach the highest score. The keys here are utilization rate (do you use your cards and keep the balance to under 30% of the max credit) and do you make your payments on time. Your credit will be higher if you have a credit card balance than if you don't. Of course, the balance shouldn't be higher than 30% of the total credit available and you need to make the payments on time.
Ironically, mortgage payments and car loans have a lesser weight unless they are late or chronically late.
Also, the age of your oldest account does play a role in your score. The belief here is that an older account shows you have experience in handling credit properly making you less of a risk.
Inquires also negatively impact your score because lenders are concerned when they see several other lenders pulling your score. The concern being that you may be taking out credit from a variety of sources making you a greater risk to pay it back. I was told by a mortgage broker that if the reporting agencies see several inquiries from the same type of lenders in a short period of time (ie - all inquiries from car dealers) they will read that as the buyer shopping for a car and they will only give it a single inquiry deduction believing they are only shopping for the best loan not buying several cars.
Although it still feels like a bit of a mystery, hopefully this gives you some insight into how credit scores are determined. Your lender can provide more information if you still have questions.
