Understanding Credit Scores

The banks are getting tougher and tougher on borrowers, and penalizing them with higher and higher interest rates. Home-owners who manage to get their finances in a mess will be paying allot more on their next mortgage renewel.

Most mortgage lenders look at your FICO score. What exactly does this score take into account?

Your payment history, which makes up the biggest chunk of your score, looks at how often you pay your bills on time. The amount of debt you owe is considered equally important. The amount of time you've had your credit cards and how much new credit you apply for all play a role in determining your score.

I. Pay Off Bad Debt
You want to aim for a score in the 700s to get more favorable loan terms. The national average, according to Fair Isaac, is a FICO score of 723. And the best way to improve your credit score in the short term is to pay off the high balances on your credit card - that can raise your FICO score 60 to 70 points overnight, says Craig Watts of Fair Isaac.

Credit bureaus can predict how much of a credit risk you are by how you handle credit card debt more than any other kind of debt, like student loans. That's because with installment loans, like mortgage payments, there is a predetermined amount you pay each month. With credit cards, you're in control of what debts you have.

II. Minimize Your Balances
Even if you pay your bills off every month, the amount you paid will be listed on your credit report. And if you spend more than 50 percent of your credit limit, that's going to negatively impact your score. In fact, you could lower your score 60 or 70 points, says Watts.

And that could make the difference between getting a good mortgage rate and a bad one. If you're within three months from applying for credit, make sure you don't charge a lot on your cards, or split the purchases between a few cards, so you keep the balances down.

III. Keep Older Cards
As we mentioned, your FICO score looks at how long you've managed your credit. So the longer you've managed your credit wisely, the better your score. If, for example, you have a card that is at least 5 or 6 years old, it's not a good idea to close those accounts.

At the same time, opening any new lines of credit - whether it's a retail credit card or a new car loan - will almost certainly lower your score by a few points.

IV. You Can Inquire About Your Credit Score Without Penalty
We've already told you what impacts your score. But here are some things that don't matter to your score at all. Your score won't be affected if you request your own credit record, or if you go for credit counseling.

It also won't impact your credit score if your employer or other lenders look at your credit score and try to solicit your business.

[Via CNNMoney.com]

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