How Lenders Keep Score

One false move can follow you around for seven years. Here's how your credit score is calculated.

Sure, declaring bankruptcy and entering the witness protection program can have an adverse effect on your credit score. But even little things can have a big impact on how lenders look at you.

There are five major areas upon which you're being judged. (Sit up straight as we list them.) They are:

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Anatomy of a Credit Report

What does your rap sheet say about you? It reveals how prompt you are in paying back loans, how much money you could borrow should you decide to go on a spending bender, and how many times you've applied for credit. What it does not reveal is your salary, business debts (unless you personally guaranteed a loan), and whether or not you're a generous tipper.

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When to Care About Your Credit

Shopping for a home or school loan? Been denied credit? Just curious about how the financial world judges you? All are great reasons to check up on your credit.

How often should you check up on your credit? You'll read "once a year" in a lot of places. Certainly, more often than that is overkill for most people.

Still, the best answer for any individual will depend on a number of personal and financial variables. What are your future borrowing needs? How much capital do you have at risk? What's your current credit exposure? How much can you tolerate the unknown?

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What's Your Credit Karma?

It's more popular than a report card and has more impact on your life than your GPA ever will. It's your credit score -- the closest thing to a financial report card there is. Here's what it is and why it matters.

Are you a 768? An 820? A 362 (gasp!)? A short time ago, you would have had no way to answer the ever-elusive question (and painfully unpopular pick-up line): "So, what's your credit score?"

Your credit score used to be a top-secret number known only to lending professionals. In March of 2001, the veil of credit-scoring secrecy was lifted. Now with just a click, you can see the three magic digits -- based on a formula developed by Fair, Isaac & Co. (FICO) or a handful of other credit reporting agencies -- that define your credit-worthiness. In FICOland, your number can range from 300 to 850. Anything above 720 is considered average.

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Check Your Credit Report Regularly

Detect Identity Fraud Early
We all know we should check our credit card statements every month for charges that we haven't made. But that only catches the thief who uses an account you know you have.

In the past few years identity fraud has risen dramatically. In this insidious form of credit fraud, a thief steals your good credit by taking over or opening accounts in your name, running up large balances, and leaving you to deal with the collectors when they come calling.

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Cosigning Means You're Financially Responsible-Consider the Risks

What would you do if a friend or family member asked you to cosign a loan? Before you answer, make sure you understand what your obligations are.

When you agree to cosign for someone else's debt, you are essentially guaranteeing payment if that person defaults. You are being asked to take a risk that a professional lender will not take. Think about it: the lender would not need a cosigner if the borrower were a good risk.

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Understand How Credit Reporting Works

You are most likely already familiar with the concept of "credit," the reputation for paying your bills on time that makes it possible for you to obtain money or goods with the understanding that you will pay for them later.

In fact, you probably have already put your credit to work for you. You employed it when you obtained an auto or student loan, used your credit card to pay for a trip or new suit, or were chosen as the tenant for your rented apartment or house. A solid history of paying your bills may also have been just the objective character reference needed to help you land your job, too.

 

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What Is Your Credit Score and How Is It Computed?

Credit scoring is a scientific method that uses statistical models to assess an individual's credit worthiness based on their credit history and current credit accounts. Credit scoring was first developed in the 1950s, but has come into increasing use in the last two decades.

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