Credit Score Calculation

These past few years, due to the financial crisis caused by subprime loans, mortgage lenders have tightened  their standards. Now it is hard to find someone who will loan you money for a house if your FICO credit score is below 620. Even if you do find a lender, your interest rate will be significantly higher than someone with an excellent score of 760. For a 30 year mortgage you may be paying tens or hundreds of thousands more in interest.

This means it's time to pay attention to your credit score!

I remember going to the bank with my mother right before I headed off to college to apply for a credit card. She told me it was time for me to build a credit history. I happily obliged. When I received my card in the mail, she reminded me time and time again that I must use it responsibly. Building a credit history is important, but you don't want to build a bad history. Mistakes can stay with you for 7 years!

FICO Score
The FICO score was developed by the Fair Isaac Corporation in the 1980s. Not only is it the original credit score, most companies still base their evaluation of creditworthiness on it.

Credit Score Basics

Your credit score is a way for lenders to assess your creditworthiness and how much risk will be involved in lending money to you. It basically quantifies your financial life by putting a grade on it. Like the credit report, the same 3 major credit agencies (Equifax, Experian, and TransUnion) provide the score, and depending on the information given, each score will vary slightly from one another.

When you apply for a credit card, for example, the card company can request a "hard pull" of your credit report and credit score to decide: 1. whether they want to issue you a card and 2. what credit limit to put on the card, and 3. at what interest rate to lend you the money.

As I mentioned earlier, once you send in an application to borrow money, lenders will be authorized to do a "hard pull" of your credit score. For the most part, hard pulls are voluntary.

Credit Report Basics

According to the Federal Trade Commission, everyone is entitled, by law, to one free credit report from each credit bureau per year. You may have heard advertisements on TV for free credit reports on websites such as freecreditreport.com or creditreport.com, but the only real free website provided by the government is AnnualCreditReport.com. The rest only provide you with free credit reports after you sign up for paid services. I highly suggest you check your report every year. It won't take you that long, but it'll give you peace of mind that the information used to determined your credit score is correct. There are 3 national credit reporting agencies: Equifax, Experian, and TransUnion.

Just after graduating from college, I applied for a new credit card in hopes of more rewards and a higher credit line than my Bank of America Student Visa Card (this was recently upgraded to a Platinum Plus Visa). Not long after, I received a letter informing me that I was rejected. I knew my credit history was short, but I had never made a late payment, carried a balance, or gone over the limit. Out of curiosity, I checked my report.

My Disappearing Credit Limit

Wrapping up my finances in 2010 turned out to be more difficult than it was supposed to be. There was the Merrill Lynch trading account I mentioned earlier, and then came this other incident with my credit report. About 3 weeks ago, I checked my credit report to make sure that there were no mistakes and everything was up to date, as I always do at the end of the year. Sure enough, I discovered something very odd. My credit utilization was a whopping 44 percent. What? How did this happen? I've been very careful about keeping my utilization below 15%.

Credit Utilization
Credit utilization is the ratio of the total amount of credit used over the total amount of credit given.