Credit Scoring and its Relation to the Lending Industry

When you apply for a mortgage, as a standard procedure in most cases, your lender will request a credit report from a credit reporting company; this is usually a local or regional company. This company in turn pulls together a credit report electronically based on the information they have in their archives about your credit history. This information usually comes from one or more of the major repositories, but it can also come from several other sources.

Along with this information, the local credit reporting company receives a numerical score which is commonly known as the credit score. This score represents several valid bits of information such as a combination of the borrower's credit history, employment history and stability, ability to save, and so on. The most famous of these scores is known as the 'FICO score', which was a model developed by the Fair-Isaacs Company several of years ago. It is believed that the Beacon and TransUnion scores are in reality scoring information provided by the Fair-Isaacs Company, but have been tweaked to a small extent by the other bureaus so as to alter them making them unique. While that may be partly true, what most people do not know is that, with information streaming into their credit file almost everyday, the scores could well change on a daily basis. That is why someone can apply for a mortgage with one company today and have a FICO score of, say, 720, and apply with a different lender a week later and that score can be higher or lower, depending on the information received at the repositories in the mean while.

Fact however remains that the Fair-Isaacs Company and the major credit repositories do not divulge exactly how the scoring model works. Due to the level of erroneous reporting to peoples' credit files, there has been pressure on the Congress lately to make the credit repositories more transparent and accountable for the accuracy of the information they report and to divulge what exactly goes into the scoring models, so that people can know what to do to and what not to, in order to improve their credit scores.

Importance of a Good Credit Score 

The lending industry is fast moving towards a 'risk-based' pricing system. In other words, this means that the higher one's credit scores, the less paper they will need to provide to prove that they are credit worthy and the interest rate and / or fees a borrower pays will be based on the level of their scores, again, the higher the credit score, the lower the interest rate.

This system of lending, while it may perhaps appear to be unfair to some, will be very beneficial for those who maintain spotlessly clean credit and it can also be looked at as a way in which good credit risks can be rewarded. In the recent past, it has been noticed by those in the industry that there has been a dramatic reduction in paperwork requirements and people seeking loans are making a conscious effort to maintain good credit scores since they are aware of 'risk-based' pricing in terms of rates and fees which has become commonplace.

In case you have recently obtained your credit report and you are not entirely happy with what has been reported, you can take the necessary steps to correct the erroneous information on it. There are also proactive steps that you can take to improve your scores, if you are anticipating applying for a mortgage anytime in the near future. While this article does not delve into the details of correcting erroneous credit information, it sure does give you a few hints as to how you can be proactive in improving your scores from where ever you are today.

" The first of these is the most obvious: make it a point to make all your payments on time.

" The second is to avoid applying for any new credit unnecessarily since every time you sign and return a new credit card offering, or open that second account at a department store because you get a 15% discount, an inquiry will be generated and that could well reduce your score.

" The third is that if you must maintain credit card balances at all, try to keep them at a level that is not more than 35% - 40% of the maximum credit limit. In other words, if the credit limit is $1,000, you must try to keep your running balance below $400. Though this is not common knowledge, consolidating all your credit cards onto one can hurt you, if the balance is at the maximum credit limit.

" The fourth is, in case you get into a dispute with the phone company and it isn't a huge amount, pay it and move on. Having one or more collections, even if they are small amounts, can really bring down your score.