How are Credit Scores Calculated?

How are Credit Scores Calculated?

When screening tenants, one of the first things that you should do is run a credit report because the information that is in the report can help you decide whether to rent to a prospective applicant.

A high score often means that the tenant will pay their rent on time every month, but a low score could indicate that the tenant might pay late or default on their lease.

A credit score isn’t the only thing that you should look at, but it is one of the most important factors.

What is a Credit Score?

FICO(r) Scores, the most common credit score, are typically used to determine creditworthiness.

Banks will pull credit scores to decide on loan amounts and interest rates.

Credit card companies use credit scores to decide whether to issue revolving credit.

As a landlord, you can use credit scores to make decisions about whom to rent to.

A FICO(r) Score is a number between 300 and 850 that combines payment and credit data from different categories. The higher the credit score, the better.

What types of data go into a credit score?

Every FICO(r) credit score is made up of data from five different categories: payment history, outstanding debt, duration of credit history, mix of available credit, and new credit.

Each category is given a different weight, and both positive and negative factors affect the final score.

For example, a history of late payments will bring down the number, and a recent history of on-time payments will bring it up.

Credit is individual

Like fingerprints, no two people have the exact same credit history.

The way scores are calculated can also vary, depending on several factors.

A person who has very little credit history might find that their scores are weighted differently than someone with a long and established history.

The exact formula used for generating a credit score isn’t public, but the different category weights are fairly standard.

  • Payment history: 35 percent
  • Outstanding debt: 30 percent
  • Duration of credit history: 15 percent
  • Mix of available credit: 10 percent
  • New credit: 10 percent

While this breakdown is fairly standard, every credit score is tailored to an individual.

You should always look at the credit score in conjunction with the report to see where the number is coming from.

After all, a credit score is only generated from the information that is found in the report.

Looking at the numbers can help you make an informed decision about who you’re leasing your home or apartment to.

An old delinquent account can pull down an applicant’s score, but if your applicant has no new delinquent accounts, you might consider renting to them.

Understanding the 5 Categories

Before making a decision based on a credit score, it’s important to understand what each category is and how it applies to your applicants.

Payment History

The first and most important category is an applicant’s payment history.

This part of their credit report is typically responsible for 35 percent of their overall score.

If they have paid their bills on time, their score will be higher.

A history of late payments will drop their score.

Keep in mind that a single delinquent account can remain on a credit report for seven years or more, so be sure to check for recent late payments.

Also, remember that a delinquent payment doesn’t show up on a credit report until it’s more than 30 days past due.

A single late rental payment could leave you in a continuing cycle of filing eviction paperwork while waiting for current paperwork.

Outstanding Debt

The amount of credit that is used by an applicant makes up 30 percent of their score.

For example, someone with large student loans might have a slightly lower score than someone with no student loans.

When deciding on a tenant, be sure to look at the total debt amount before making a decision.

Combined with their income, this information can tell you which tenants might have trouble meeting their rental obligations and which ones shouldn’t have any trouble.

Duration of Credit History

A longer credit history generally translates into a higher credit score. Every score includes:

  • The newest account, oldest account and average age of accounts
  • The length of time since a person used those accounts

This information may not seem like it has immediate value, but you should take into consideration how often someone uses their revolving credit.

If they frequently resort to credit cards and maintain increasingly large balances, the individual may have a spending problem.

Mix of Available Credit

The types of accounts that someone has also plays a role in their credit score.

Retail stores, credit cards, auto loans, student loans, and other types of credit from 10 percent of the total score.

As a landlord, you may not care what type of credit an applicant has, but you may want to see if the information reduces an individual’s score.

New Credit

When someone has several recently opened lines of credit, that can be a warning sign.

Those new to credit have a higher risk of default, and applying for several accounts at one time can reduce a total score by up to 10 percent.

Knowing where the credit score number comes from and looking at an applicant’s total credit report can help you make the right decision when you’re screening tenants.