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How credit scores work

*NOTE – This article was originally written in September of 2006 for the newsletter.

All investors realize sooner or later that their credit score can have a major impact on what type of financing can be acquired when purchasing new properties. It happens all too frequently: the perfect property has been identified, an offer has been made, but the financing terms aren’t agreeable because the credit score hasn’t allowed for a lower rate or flexibility in terms. An investor’s credit score can greatly affect the type of financing options available.

Just what makes up a credit score? There are basically five categories that determine what one’s score will be: Payment history, Amounts Owed, Length of Credit History, New Credit, and Types of Credit Used. These five categories are weighted to compile an average credit score for a consumer, ranging from a low of 300 to a high of 850 (depending on the source, the average credit score is 678). The most heavily weighted categories are payment history and amounts owed, making up 35% and 30% respectively. Following payment history and amounts owed are length of credit history (15%), new credit (10%) and types of credit used (10%).

Since a credit score is a snapshot of one’s credit risk at a particular point in time, it figures that if there have been any recent late payments or there are many credit cards that are maxed out, one’s credit score will be affected negatively. It can be a slow process to improve negative credit, even though the scores themselves are quick to worsen when a late payment or bankruptcy is reported. In other words, it’s easy to lower a credit score, but not so easy to improve it.

Before putting a bid on a contract, it is best to have an idea as to what one’s credit score and overall financial profile will yield in terms of financing options. Contrary to common belief, credit scores are not affected by requests made by a lender in order to provide a prequalification. In fact, a borrower can have a number of lenders run their credit within a 14-day period, but it only counts against the credit score as one inquiry.

*Thanks to Alysa McLaughlin of Doering Mortgage on putting together this article. Give her a call at (636) 734-8396 or visit her on the web at loanmomma.net.

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