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Understanding Credit

Knowing up front how this system works and where you stand can be invaluable.

There are a lot of unforseen pitfalls on the road to owning your own home. The largest one can be your credit score. Knowing up front where you stand can be invaluable, so let’s take a look at how your credit score is determined.

What is a credit score?

A credit score is a number, usually between 350 and 850, which lenders use to estimate risk. The higher the number, the lesser the risk that the borrower will default rather than pay back the loan. The three major credit reporting agencies, Equifax, TransUnion and Experian, don’t always produce the same score - sometimes they use different scoring software. This means you could potentially get a different number from each agency.

When working with a Lender, they will look at your FICO score. FICO stands for Fair Isaac Corporation and is the software used to calculate a great number of credit scores. To receive a FICO score, all of the data from your credit report is entered into the software which analyzes it and returns with your score.

Here is a basic guide to how your FICO score is determined:

  • 35% - Your Payment History
  • 30% - Amounts You Owe
  • 15% - Length of Your Credit History
  • 10% - Types of Credit Used
  • 10% - New Credit

Your payment history looks at how you have paid your bills in the past, how many accounts you have paid as agreed, which (if any) are or have been delinquent and how often, and if there are any negative public records or collections against you.

Amounts you owe looks at your outstanding debt, how many accounts you owe on, what types of accounts they are, your revolving credit lines, installment loans and if you have any accounts with zero balances owed.

The length of your credit history tracks the total length of time on your credit report, how long your accounts have been opened, when was the last activity on those accounts and how long you’ve had ‘good’ history. The longer, the better for you and your FICO score.

The types of credit used looks at the total number of accounts you have and their types (revolving, mortgage, installment). A good mixture of different kinds of accounts usually generates a better score.

Having a firm understanding of what affects your Credit Score will help you when you decide to purchase your first home.

When you are looking at buying your first home, staying on top of your credit is essential and understanding how your credit score can affect the interest rates you are offered by your lender will help you make the right decisions moving forward.

Your FICO (Fair Isaac Corporation) score is a three digit number usually between 350 and 850 and is used by lenders to determine the amount of risk you pose should they lend you money. It also affects the rates you will be offered when applying for a loan. Your score is determined by information on your credit report and that score can determine whether or not you are offered a higher or lower interest rate.

Some other factors that can affect your rate include:

  • How long you've been at your current residence.
  • Your debt to income ratio.
  • How long you've worked at your current job or in your chosen field.

Different kinds of information affect your score in different ways. For example, bankruptcies, Tax Liens, Monetary judgements and Collections can all adversely affect your credit report and score. Debts that have been paid off but still show on your report, inaccurate information and old debts (7+ years) can also adversely affect your score.

In today's world, managing your credit report is an absolute must. The federal Fair Credit Reporting Act (FCRA) requires that U.S. consumers be entitled to a free credit report each year. The government's goal is to make sure that consumers stay informed, fight identity theft, and get fair treatment.

The official site setup for consumers to access their free annual credit report is: www.annualcreditreport.com

A credit specialist may be needed to help you understand and manage your credit, but some basic principals hold:

Fix errors on your report. If you find an error on your credit report, put it in writing and notify the credit-reporting agencies to have it fixed or removed. By law, they have 30 days to investigage your claim - if they can't verify the information, they have to remove it.

Pay your bills on time. Showing a prompt payment history goes a long way towards buidling confidence.

Make full payments on revolving credit accounts.

If you find that your financial situation is more serious than you thought, consult with a non-profit credit counselor.

We hope that this information has helped you to better understand how important your credit history can be when looking towards your future.

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