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Many people are unaware of what a credit score actually means. In fact, a survey of 1,000 Americans taken in September 2004 demonstrated that only one third of people knew that a credit score was a measurement of how likely a person is to pay off a loan. Having a good credit score is necessary when it comes to applying for loans for cars, mortgages, and credit cards. Furthermore, having a bad credit score can lead to denial of basics such as a phone line in your home. Therefore, it is important for consumers to understand how a credit scores affects them and how it is determined in the first place.

Calculating the Credit Score

In essence, a credit score tracks how well a person incurs debt and how good that person is at paying the bills on time. Businesses, including lending institutions, look for a high score with potential customers because the higher a person’s credit score, the more likely that person is to be responsible with finances and the more that person can be trusted to pay back debts.

A credit score may vary from one credit-reporting agency to the next since they do not all necessarily receive the same information from businesses. Some businesses report to all three of the major reporting agencies, while others may only report to one or two. In addition, the statistical pool used by each agency may vary slightly, leading to a different credit score. All of the agencies, however, utilize the same software when it comes to determining credit scores. Fair Isaac and Company (FICO) develops this software and, therefore, the credit score is often referred to as the FICO score.

Score Factors

A person’s credit score is not static. It changes all the time. Every time a bill is paid on time or late it is reflected on the credit score. In addition, each time a person takes out a new loan or applies for a new credit card, the credit score changes. This is because the credit score is based on the person’s financial history and attempts to make a prediction at how responsible the person will be in the future.

The final score is highly objective and based on statistical data. Points are gained based on specific factors such as late payments, payment history, outstanding debt, and the length of time an account has been open. All of this information is compared to the statistics of people with similar profiles to determine a final credit score.

JP Burkhart recommends that you visit credit score rating scale for more information.

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When applying for a mortgage loan, you’ll likely encounter the term “FICO” at some point. And even if you don’t hear the phrase mentioned, FICO is there in the background, affecting your chances of loan approval and influencing your interest rate.

So what is FICO, and how does it affect your chances of qualifying for a mortgage loan?

FICO is a computerized credit-scoring model named after the Fair Isaac Corporation, the company that developed it decades ago.

How FICO Affects You
The big three credit-reporting bureaus - Experian, Equifax and Trans Union - use the FICO scoring model to convert your credit history into a credit score. Mortgage lenders in turn use that score to decide whether or not you qualify for a mortgage loan, and to determine what interest rate you’ll pay.

Of course, there are other factors that influence these decisions, but FICO plays a leading role. In other words, your FICO score helps mortgage lenders determine your credit worthiness, how likely you are to pay off your debt, and what risk category you fall into.

The higher your FICO score the better, as evidenced by the scoring brackets below:

650 - 850: The “go ahead” category. Low risk to lender. Applicant has good chance of qualifying for a mortgage loan.

620 - 650: The “possible” category. Moderate risk to lender. The lender will likely request more information from the applicant to base their qualifying decision on.

620 or below: The “risky” category. Highest risk to lender. Applicant will probably have trouble obtaining a mortgage loan.

FICO Factors
Your FICO score is based on your credit report (which is your credit history on paper). Your credit report includes such things as:

• Your debt-to-income ratio
• Number of credit cards held
• Credit card balances
• Other outstanding debt
• Payment history
• Payment delinquencies

How to Keep a High FICO Score
There aren’t any “quick fixes” when it comes to raising your FICO score. Improving your credit is a gradual, cumulative process. Paying off credit cards will help, but it’s best to take a more preventative approach:

Pay your bills on time. Don’t apply for credit too often. Minimize your debt (to improve your debt-to-earnings ratio). In other words, keep a clean financial record.

Conclusion
Think of FICO as a little man watching how you handle your finances peering over his librarian-style glasses and scribbling notes onto a clipboard. Give him good things to write about, and you’ll have less to worry about when you apply for a mortgage loan.

* Copyright 2006, Brandon Cornett. You may republish this article in its entirety, provided you leave the byline, author’s note and website hyperlink intact.

About the Author

Brandon Cornett is the editor of HomeBuyingInstitute.com, one of the Internet’s largest and most respected libraries of home buying information — more than 100 expert articles in 12 different home buying categories! Put this knowledge to use by visiting http://www.HomeBuyingInstitute.com

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So just why DO errors show up on your credit report?

According to MyFICO.com, errors in a person’s credit report might mean their file is incomplete, contains information about another person, or any number of reasons:

Sometimes it’s a simple credit report error like transposing numbers in a Social Security number.

Sometimes it’s a different name. A woman gets divorced, then remarries. A man applies for a credit card using an informal name (”Pete” instead of “Peter,” etc.)

Sometimes a clerical error is made. A hand-written application might be illegible by the person typing the information into a computer system.

Sometimes a bank will be bought out, and credit information appears in both records (Note: this has happened to me for a truck I had financed at a local bank … the local bank was later bought out by a national firm. That one loan was reported as two, and the first showed never being paid off until I cleaned up my credit report and the mistaken entry was eliminated).

Sometimes payments were applied to the wrong account. Without checking your credit report, you’d never know that there was a late charge a year ago on an account, possibly a late fee you weren’t even aware of.

Sometimes accounts you THOUGHT you had closed out and stopped making payments on actually are still open and are showing late fees.

Having credit report errors will not prevent you from getting credit. But errors — whether they are your fault or not — could effectively lower your FICO credit score. Having a low FICO credit score, in turn, could mean that you’ll be paying more for refinancing your mortgage or getting a home equity loan at favorable terms.

Our suggestion: Get your free credit reports from

http://www.AnnualCreditReport.com and check them over for accuracy. We’ve posted free tips at http://www.how-to-fix-your-credit-report.com to help make the process go smoother for you.

Your credit score is a reflection of your own past personal credit history, it is not etched in stone. Take action to improve your credit score, and you’ll see your FICO credit score start to rise and the interest rates you’ll be offered on future loans begin to drop!

Steve Johnson is publisher of http://www.FindHow2.com — a growing collection of free “how-to” articles focused on credit repair, debt management and financial planning. He also publishes his blog, http://www.how-to-fix-your-credit-report.com. He can be reached at fixyourcreditreport@gmail.com.

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