What is a Credit Score?

Your Credit Score: What It Means & How it Works

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Before they decide on the terms of your loan, lenders must know two things about you: your ability to repay the loan, and your willingness to repay the loan. To understand whether you can repay, they look at your income and debt ratio. To assess your willingness to repay, they use your credit score.


Fair Isaac and Company formulated the original FICO score to help lenders assess creditworthiness.


Your credit score comes from your history of repayment. They don't consider income or personal characteristics. These scores were invented specifically for this reason. "Profiling" was as dirty a word when these scores were first invented as it is now. Credit scoring was invented as a way to consider solely that which was relevant to a borrower's willingness to pay back the lender.


Past delinquencies, payment behavior, current debt level, length of credit history, types of credit and the number of inquiries are all considered in credit scores. Your score is calculated wtih both positive and negative items in your credit report. Late payments lower your score, but consistently making future payments on time will improve your score.


Your credit report must contain at least one account which has been open for six months or more, and at least one account that has been updated in the past six months for you to get a credit score. This payment history ensures that there is sufficient information in your report to calculate a score. Should you not meet the criteria for getting a score, you may need to work on a credit history before you apply for a mortgage loan.

How FICO Credit Scores Are Calculated


Since we live in an automated world, it should come as no surprise that your ability to repay your mortgage loan boils down to just one number. Credit reporting agencies use your history of paying all types of loans in order to create this score.


All three credit agencies (Equifax, Experian and TransUnion) use a slightly different system to arrive at a score. The original FICO model was developed by Fair Isaac and Company. While Experian still calls its score "FICO", TransUnion calls its score "Beacon" and Equifax uses "Empirica." While each of the models considers a range of data available in your credit report, each agency uses the following to build a credit score:


  • Your Credit History - Have you had credit for many years, or for just a short time?
  • Late Payments - Do you have any payments later than 30 days?
  • Your Credit Card Balances - How many accounts? How much do you owe on your accounts?
  • Credit Inquiries - How many times have lenders pulled your credit for the purpose of lending you money?


These factors are assigned weights based on the formula being used. The results are added up and distilled into a single number. Credit scores range from 300 to 800. Higher is always better. Most home buyers have a score above 620.

Not Just for Qualifying

Did you know? FICO scores affect more than your ability to get a loan. They also affect your interest rate. Lenders give lower interest rates to individuals with higher scores.

Can I Raise My Credit Score?

Is there any way to improve your credit score? Some companies promise quick fixes, but they can't do anything different than what you can do — for free. You must, of course, remove any incorrect data from your credit report; this is really the only way to quickly improve your credit score.

Getting Your Credit Score

To improve your FICO score, you've got to have the reports that are used to build it, and of course, you need the score itself. Fair Isaac has created a web site (www.myFICO.com) that lets you do just that. For a reasonable fee, you can get your FICO score from all three agencies, along with your credit report. Also available are helpful information and tools that can help you analyze what actions might have the greatest impact on your FICO score.


You can get a free credit report every year from all three agencies when you visit AnnualCreditReport.com. These reports do not include a free score, but it's very inexpensive to get one at the same time.

How Can You Improve Your Credit Score?


It's virtually impossible to change your score in the time between when most people decide to buy a home or refinance their mortgage and when they apply. So the short answer is, you really can't "on the spot." But there are strategies you can live with to make sure when you apply for a loan your score is as high as possible.


Make sure that the information each of the three credit reporting bureaus has on you is consistent and up to date. Order a copy of your credit report about once a year, and dispute any inaccuracies.


Note: Theoretically, if a series of credit reports is requested on your behalf during a limited amount of time, your score goes down until time passes without any inquiries. Changes in the law though have made "consumer-originating" credit report requests not count so much. Also, a series of requests in relation to getting a mortgage or car loan is not treated the same as a number of credit card requests in a limited time. This is because the credit bureaus, and lenders, realize that people request their own credit reports to keep up with what's on them, and smart consumers shop around for the best mortgage and car loans.


Unsolicited credit card solicitations in the mail don't count against your credit report, so don't worry.


The two main components of your credit score are your payment history and the amounts you owe. Bankruptcy filings and foreclosures, which can stay on your credit report for as long as 10 years, can significantly lower your score. It's never a good idea to take on more credit than you can handle.


Late payments work against you. It's extremely important to pay bills on time, even if it's only the monthly payment.


Don't "max out" your credit lines. Since the size of the balance on your open accounts is a factor, lower balances are better.


It's said that by carefully managing your credit, it's possible to add as much as 50 points per year to your score.

Reasons for Mistakes on Your Credit Report


Credit report errors occur for a number of reasons but they can all have a negative impact on your eligibility for any future credit. It's important to stay on top of your credit report to avoid any mistakes made by the creditors and credit bureaus —Equifax, Experian and TransUnion. Some common reasons for credit report errors include: 


  • The individual has applied for credit under several different names (i.e. John Doe and Jonathon Doe)
  • Someone made a clerical error in entering or reading information (names, social security numbers, addresses, etc.) from a handwritten application.
  • Mix ups with common names. For example, there is likely more than one John Smith living in New York City and often there is the chance that information intended for one John Smith might appear on another John Smith's credit report as he applies for a mortgage.
  • The individual gave an inaccurate Social Security number or the number was misread by the creditor.
  • Loan or credit card payments were inadvertently applied to the wrong account.


No matter what the reason, the erroneous information could reflect poorly on your credit file, thus causing approval problems when the time comes to apply for a job or obtain a mortgage. If you find errors, no matter how small, be sure you get them fixed, and make sure that you contact all three credit bureaus with your change.

Disputing Credit Reports


Your credit report is a record of your credit activities. It lists all of your credit card accounts and loans, the balances as well as your payment history. It also shows if any action has been taken against you because of unpaid bills such as a lawsuit or bankruptcy filing. Because businesses use this information to evaluate your applications for credit, insurance and employment, it’s important that the information in your report is complete and accurate, especially if you plan to make a big purchase like a home.


The Fair Credit Reporting Act (FCRA), enforced by the Federal Trade Commission (FTC), is designed to promote accuracy and ensure the privacy of the information used in consumer reports. Under the FCRA, both the credit reporting agency (CRA) and the organization that provided the information to the CRA (usually the credit card company) must correct any errors or incomplete information in your report.


If you do encounter a mistake on your credit report, several steps need to be taken to correct the matter:


  1. The first thing to do is get a copy of your credit report from each of the three major CRAs: Equifax, http://www.equifax.com; Experian, http://www.experian.com; and TransUnion, http://www.tuc.com.
  2. In a written letter, tell the CRA what information you believe to be inaccurate. Include copies (not originals) of documents that support your position. Provide your complete name and address, identify each item in your report you dispute, and request deletion or correction. Be sure to make copies of your dispute letter and enclosures.
  3. Send your letter by certified mail, return receipt requested, so you can document what the CRA received.
  4. The FCRA mandates that all CRAs reinvestigate the items in question — usually within 30 days — unless they consider your dispute frivolous. They also must forward all relevant data you provide about the dispute to the credit card company. After the credit card company receives notice of a dispute from the CRA, it must investigate, review all relevant information and report the results to the CRA.
  5. If the disputed information is found to be inaccurate, the credit card company must notify all nationwide CRAs so they can correct this information in your file. Disputed information that cannot be verified must be deleted from your file.
  6. When the reinvestigation is complete, the CRA must give you the written results and a free copy of your report if the dispute results in a change. If an item is changed or removed, the CRA cannot put the disputed information back in your file unless the credit card company verifies its accuracy and completeness, and the CRA gives you a written notice that includes the name, address, and phone number of the credit card company.
  7. In addition to the CRA, you should also write to the credit card company about the error. Again, include copies of documents that support your dispute. If you are correct — meaning the information you disputed is found inaccurate — the credit card company cannot use it again. Further, at your request, the CRA must send notices of corrections to anyone who received your report in the past six months.

Bankruptcy & Your Credit Score


A bankruptcy filing delivers a devastating blow to your credit and FICO score, but it doesn’t mean you have to wait 10 years before you can qualify for a mortgage. Many consumers who have filed for bankruptcy have been able to obtain a mortgage, although it is often at a higher rate than someone qualifying for a prime or "A-paper" loan.


While credit card companies may care about what happened before you filed for bankruptcy, many mortgage lenders are more interested in your recovery — what you’ve done since your filing. It won’t happen over night, but here are some tips and things to keep in mind when you inquire about a mortgage with a tarnished credit past:

Give explanations.

No mortgage lender is going to ignore the fact that you’ve filed bankruptcy and he or she will likely want to know the cause of the filing. Your lender will be particularly interested in whether the same situation could happen again. Your chances of being qualified are much better if your bankruptcy was caused by a single event such as a loss of employment or a death in the family, than if it was the result of “just spending too much.”


If the bankruptcy resulted from a single event, it is important to show your lender paperwork describing the incident, such as the layoff notice or death certificate. You may also want to bring in court documents to indicate when the bankruptcy was filed.

Demonstrate good money habits now.

Many people who file bankruptcy swear off credit altogether, however, it is important to re-establish your credit rating. Get a secured credit card or take on some sort of loan — furniture, a car or a major appliance — to demonstrate that you are able to make timely payments. Make sure you are making other payments (utility bills, cell phone, etc.) on time as well. You won't turn things around in a year but your credit score will improve over time.

Dispute any credit report errors.

There’s no need to add to your troubled credit history with errors on your credit report. Get a copy of your credit report from each of the three major credit reporting agencies: Equifax, Experian, and TransUnion. If you encounter any errors, inform the CRA in writing what information you believe to be inaccurate and request deletion or correction.

Save your money.

Lenders may be more willing to loan you money if you’ve saved up a considerable amount of money for a down payment.

Live within your means.

Even subprime lenders won’t risk loaning you money for an opulent oceanfront mansion. Think small when the time comes to look for a home. Smaller homes often mean smaller mortgages.

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