The after effects of the mortgage loan crisis are going to be felt for years to come. Already loan and mortgage lenders are tightening the criteria of lending and you may feel the change when you are out shopping for a loan.
FICO credit scoring
The FICO credit score is the most widely used primary factor to assess you risk as borrower. The score ranges from 300 –850. The higher the score, the better the interest rates and terms offered to you on credit lines and loans. A score of 700 and above has so far been considered a healthy number, but this is now changing with the lenders becoming more risk averse. The lenders have now upped their criteria for eligibility and better borrowing rates by almost 20 –40 points.
There are five key factors that affect your credit score. These include your payment history, the debt owed, how much of your available credit line is used up (debt utilization ratio), your mix of credit and the duration for you have been building your credit history.
Debt ratio and payment history
Your debt utilization ratio and your payment history accounts for ~65% of your credit score. If you have a very high usage of your available credit line, say around 70-80% or more, then it will hurt your credit score negatively. A high debt utilization ratio indicates that you are a big user of credit and hence the risk associated is also higher. Late payments also hurt your credit score adversely. They should be avoided at all costs, as they could be the single biggest factor as to why you end up with a bad credit score.
Both closing and opening a credit line also pulls down your credit score. Closing a credit line affects your debt utilization ratio, which goes up and consequently brings down the credit score. So closing credit lines, which are relatively small, won’t hurt your credit score much. Opening a credit line indicates that you are seeking more credit, and can knock your credit score by a few points.
The impact of defaults
The worst hit to your credit score comes from loan or debt repayment defaults. They practically remain as permanent blemishes on your credit history and score for years to come. Such blemishes could make it impossible in the future for the types of expenditures a homeowner could once afford, such as sailing vacations involving private charter to intriguing and unforgettable destinations abroad at foreign ports of call. Home foreclosures and bankruptcies can knock off as much as 200 or more credit score points. Rebuilding from here would a serious uphill task and may even take years to correct. It’s always wise to manage your debt carefully and avoid delinquencies and defaults of any and every nature.