Credit scores – how do they work?

“We’ll just have to check your credit score.” You have probably heard this phrase if you have made a purchase that requires financing.

Unless you are one of those people that have an unlimited supply of cash, most likely you’ve borrowed to buy a new car or pay for some other major expense.

While you sit and wait, a loan officer enters your name into a computer and almost immediately a number comes up indicating your credit score.

But what does this number mean and how is it determined?

Your credit score is based on a statistical analysis of your past credit history. In other words, it is a number used by financial institutions to determine how likely you are to pay your bills on time.

Your history of loan and bill payments, as well as your current debt to income ratio all factor into a credit score.

Although it may seem a little scary to think that someone is keeping track of your financial status, banks and lending institutions find it necessary to avoid loaning money to people with a history of not paying their bills.

Several statistics factor into determining your score including:

● payment history

● paying your bills on time

● credit utilization

● length of history

● type of credit used

● recent searches for new credit

A higher score indicates you have a history of repaying your debts and the more likely a bank will loan you money – it’s that simple.

There are several institutions that monitor the credit worthiness of individuals.

The Fair Isaac Corporation (FICO) is probably the most well known credit monitoring institution in the U.S. FICO is the most widely used credit score model in the U.S. – especially when it comes to home mortgages.

Other credit bureaus including Experian, TransUnion, and Equifax, all have reports based on credit information.

Although your credit score is based on your ability to pay your mortgage, loans, and bills, your annual income is not included in the equation when determining your score.

Keeping a high number when it comes to your credit score will be to your advantage when you need to borrow money – either for a relatively short term loan like borrowing to buy a new car – or for a long term venture such as applying for a home mortgage.

The easiest way to maintain a high credit score is by using common sense principles when it comes to your financial situation.

Pay your bills on time and don’t let your credit card payments get behind.

Due diligence, when it comes to maintaining your good credit, will pay off later when you do need to apply for a loan or mortgage.