What do lenders consider when they look at your credit report? It's a simple question with a complicated answer, because there are no universal standards by which every lender judges potential borrowers. It can depend on both the lender and the type of loan.
Of course, there are some items that will increase or decrease your odds of approval just about everywhere. Looking at what makes up your FICOscore (the most widely used credit scoring model) is a good place to start. FICO scores range from 300 and 850, with anything 670 or above considered good or better. If your score is much lower than that, you will probably find it difficult to borrow money at favorable interest rates and maybe at all.
Key Takeaways
- Payment history accounts for 35% of a borrower's FICO score and can be the most important factor for lenders.
- Missed payments and large amounts of outstanding debt are significant red flags for lenders.
- Lenders also like to see that applicants have experience using multiple types of credit—such as credit cards and car loans. They may be especially interested in how the consumer has handled the type of credit they're applying for now.
How Credit Scores Are Calculated
FICO scores are calculated based on five weighted factors: payment history, amounts owed, length of credit history, new accounts, and credit mix. Here's a look at each.
Your Payment History
More than anything else, lenders want to get paid back. Accordingly, a potential borrower's track record of making on-time payments is of particular importance. In fact, in calculating a person's FICO score, payment history is the single most important factor, accounting for 35% of the score. Nobody is excited about lending money to someone who has been lax in repaying their debts.
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Late payments, missed payments, mortgage default, and bankruptcy are all red flags to lenders, as is having an account that's been referred to a collection agency for lack of payment. While a few blemishes on your payment history may not stop lenders from extending credit to you, you might be offered a smaller loan or credit line than you would have otherwise qualified for, and you are likely to be charged a higher rate of interest.
Your Amounts Owed
Large amounts of outstanding debt are another significant concern to lenders. It's a bit of a paradox, but the less debt you have, the greater your chances of getting credit. The idea is that someone with a large amount of existing debt may have greater trouble paying it back.
What constitutes a large amount will vary from individual to individual. Lenders use various metrics, such as your credit utilization ratio. That's the amount of debt you currently owe as a percentage of all the credit that's available to you. Generally speaking, the lower that percentage, the better. Outstanding debt accounts for 30% of your FICO score.
Note
FICO's principal competitor, VantageScore, looks at a similar list of items but assigns them slightly different weights.
The Length of Your Credit History
An established track record of responsible credit use is good for your credit rating. In particular, lenders like to see that you've maintained some credit accounts (and kept them in good standing) for a significant period of time. The length of your credit history makes up 15% of your FICO score.
Your New Accounts
Lenders frown on applicants who have opened a bunch of new credit accounts in a short span of time. If they see that in your credit report, they can't help but wonder why you need so much credit. They will also have questions about your ability to repay should you suddenly max out all those accounts. New credit makes up 10% of your FICO score.
So if you want to maintain a good credit score, think twice before you open an account just to get that free travel mug or umbrella, or even that tempting 10% discount on your purchase if you sign up for a store account.
Warning
Signing up for several new credit cards within a short period of time may hurt your credit score.
Your Credit Mix
From credit cards to car loans and mortgages, there are a variety of ways consumers use credit. From a lender's perspective, variety is good. Lenders like to see that their prospective clients have experience using multiple sources of credit in reliable ways, particularly the kind of credit they are offering. That doesn't mean, however, that you should open a new type of credit account just for the sake of your credit score. As FICO itself says, "Don't worry, it's not necessary to have one of each." FICO score calculations give a 10% weight to the types of credit an individual has.
Important
Most people have more than one FICO score. For example, FICO offers scoring models tailored to mortgage lenders, auto lenders, and credit card issuers. So even if you obtain your credit score, it may not be identical to the one the lender is using.
What Else Do Lenders Consider?
While your credit score plays an important role in helping you qualify for loans and other forms of credit, it is not the only thing that lenders consider.
For example, lenders will usually want to know about your income, assets (such as bank accounts), and employment history—none of which are included in your credit reports or factored into your credit score.
In many instances they will want to know what you are planning to do with the money. For example, if you are applying for a mortgage, they will require information about the home you plan to buy and insist on an independent appraisal to make sure that you are not overpaying for it.
If the loan is secured, they will want to know about the collateral you are putting up. In the case of mortgages, for example, the home itself typically serves as collateral, and the lender can take possession of it if you fail to make payments. With a car loan, the vehicle usually serves that purpose.
Credit cards, by contrast, are generally unsecured, so the issuer is relying entirely on its assessment of your creditworthiness.
How Can You Obtain Your Credit Report?
By law, you are entitled to a free credit report at least once a year from all three major credit bureaus—Equifax, Experian, and TransUnion. You can obtain them at the official website AnnualCreditReport.com. It is a good idea to review your credit reports periodically for errors, and especially when you're thinking of applying for credit. If you find errors, you can ask the bureau to correct them.
Are All Three Credit Bureaus' Reports the Same?
Not necessarily. Some creditors report information on you to all three credit bureaus, while others report to one or two bureaus or none at all. So the information in your credit reports can vary from one bureau to another. Because you are unlikely to know which credit report or reports a particular lender will be using to judge you, it can be useful to request all three.
How Can You Obtain Your Credit Score?
You can often obtain your credit score free of charge from your bank or credit card issuers. There are also reputable online sources for free credit scores. Bear in mind, though, that most people have more than one credit score, so the one you obtain may not be identical to the one a lender is using.
The Bottom Line
If you're applying for a credit card or loan, you can expect the lender to scrutinize your credit report to determine how good a risk you are. In addition, it is likely to request other financial information from you that isn't included in your credit report. The better you look from that perspective, the more likely you are to be approved for credit and at a good interest rate.
