What do lenders look for when they look at your credit report? This is a simple question with a complicated answer because there is no universal standard by which all lenders evaluate potential borrowers. This can vary depending on the lender and the type of loan.
Of course, there are many factors that will increase or decrease your chances of approval anywhere. Looking at what makes up a FICO score (the most commonly used credit scoring model) is a good place to start. FICO scores range from 300 to 850, with scores above 670 considered good or excellent. If your score is much lower, it may be difficult to get a loan at a favorable interest rate or at all.
How Credit Scores Are Calculated
Your FICO score is calculated based on five weighted factors: payment history, amount owed, length of credit history, new accounts and credit mix. An overview of each is as follows:
Your Payment History
Lenders want a return on their investment more than anything else. Therefore, a prospective borrower’s on-time payment record is particularly important. In fact, when calculating a person’s FICO score, payment history is the most important factor, accounting for 35% of the score.
No one will lend money to someone who cannot repay their debt.
Late payments, missed payments, mortgage defaults, and bankruptcy are all warning signs to creditors, and failure to pay can result in your account being sent to collections. A few blemishes on your payment history won’t prevent a lender from granting you credit, but you may be offered a smaller loan or line of credit than you applied for and charged a higher interest rate.
Your Amounts Owed
Huge amounts of unpaid debts are another major concern for lenders. It may be a little paradoxical, but the less debt you have, the more likely you are to get a loan. The point is that people with a lot of debt may have more trouble repaying their debt.
What constitutes a large amount varies from person to person. Lenders use a variety of indicators such as credit utilization rate. This is an amount expressed as a percentage of any loans you currently have. Usually, the lower the percentage, the better. Outstanding debt accounts for 30% of your FICO score.
The Length of Your Credit History
A proven history of responsible credit use is good for your credit score. In particular, lenders want to see that you have maintained multiple credit accounts in good standing over a long period of time. The length of your credit history accounts for 15% of your FICO score.
Your New Accounts
Lenders don’t like applicants who open too many new credit accounts in a short period of time. When they see this on your credit report, they question why you need so much credit. In addition, they will question your ability to repay if you suddenly limit all your accounts. The new credit will be applied to 10% of your FICO score.
So if you want to maintain a good credit score, think twice before opening an account to get a free travel mug or umbrella or 10% off your purchase when you create a store account.
Your Credit Mix
From credit cards to auto loans and mortgages, there are many ways consumers use credit. From a lender’s perspective, diversity is good. Lenders want to make sure that potential customers have a solid track record of using a variety of credit sources, especially the types of credit they offer. However, this does not mean that you need to open a new credit account for the sake of your credit score. FICO says, “Don’t worry, you don’t have to have one of each.” The FICO score calculation gives a 10% weight to a person’s credit type.
What Else Do Lenders Consider?
Your credit score plays an important role in getting a loan and other types of credit, but it’s not the only thing lenders consider.
For example, lenders typically want to know about your income, assets (such as bank accounts), and work history, but this information is not included in your credit report or credit score.
In most cases, they want to know what you plan to do with the money. For example, if you’re applying for a mortgage, you’ll need information about the property you want to buy and you’ll need an independent valuation to make sure you’re not paying too much for the property.
Once the loan is secured, they will want to know what collateral you are offering. For example, with a mortgage, the house itself usually acts as collateral, and if you don’t make payments, the lender can take possession of the home. For car loans, a vehicle usually serves this purpose.
