Your Credit Report and Your Credit Score

Borrowing money in today's world is a lot more complicated than it used to be. Nowdays, you have a permanent credit history that follows you wherever you go. Banks and other credit issuers have a wide variety of options to evaluate your credit worthiness, and how much risk will be involved if they were to give you a loan.

When you decide to borrow money for a car, a house, or sign up for a new credit card, the issuer has the option to request and view your credit report and/or your credit score.

Your credit report is a detailed listing of your past and current credit activity. There are three main credit bureaus (TransUnion, Experian, and Equifax) that collect and report this information about you. Your credit report can contain several years worth of credit history, up to the number of years that is allowed by law. It is important for you to review your credit report regularly, looking for and challenging incorrect information. Because your credit report can be reviewed by anyone issuing you credit or offering you employment, you need to keep your credit report as accurate as possible. You can obtain your credit report once a year and free of charge by going to AnnualCreditReport.com.

Your credit score, on the other hand, is a calculated number based on your credit history. There are several types of credit scores, but the most popular scores are the FICO score and the VantageScore. Each score is calculated by proprietary algorithm (math formula). The FICO score is a number between 300 and 850, that a credit issuer (whether human or software) can quickly use to determine a person's credit worthiness. The Fair Issac Corporation has published general guidelines that determine a person's FICO score (see the Credit score article on Wikipedia for more information). Thirty percent of a person's FICO score calculation is determined their credit utilization (how much credit they have available on revolving credit, verses how much outstanding debt they have on those lines of credit). The VantageScore is similar to the FICO score, except that it is produced by the three credit bureaus. Its score has a range of 501 - 990. It uses a similar algorithm with a credit utilization of 23% being used to determine a person's score.

While it is important to regularly review and maintain your credit report, it is not important to make changes to your lifestyle and credit habits in order to maintain or raise your credit score. Your credit score is not an indication of wealth, but an indication that you can manage debt and the interest that comes with debt.

If you begin to live a more frugal lifestyle by paying off and closing your available lines of credit, your credit score will most likely drop. Back in 2006, I had a credit score of 750. Today, because earlier this year I paid off and closed a car loan and a credit card account, it has most likely dropped. No worries, when my wife and I apply for a new mortgage (the only debt we are willing to take on in the future), we'll find a lender that does manual underwriting.

Manual underwriting requires the lender to review your financial situation, including your credit report, your assets, and your liabilities. Because our only liability is our current mortgage (before we buy a new house we plan on selling our current house) we would have zero liabilities, and be in a great position to take on a new mortgage.

What are your experiences with credit reports and credit scores? Do you believe maintaining your credit score is important to your financial health? Please post in the comments below.

Wants vs Needs

Our inner child says 'I want it, I want it, I want it!' Our outer adult, in turn, says the item is not a need, and we have other, more important needs right now. We all feel these conflicts between our wants and needs.

Nearly all of us have a limited amount of spending money, and we cannot always fulfill all of our needs, let alone all of our wants.

Let's define these two terms:

• A want is an item or service that you could live without, whether temporarily or permanently. For example, a want could be a newer, larger TV.
• A need, on the other hand, is an item or service that is required to allow you to maintain your health and well-being (food, medicine, healthcare, insurance, etc), have a place to live (your home or apartment), household services (electricity, phone, etc) and transportation (a car to get to and from work). Some have other needs, such as a cell phone if they work outside.

Many of us (I'm guilty of this) will rationalize a new purchase and feel that the item which was a want yesterday is now a need, and should be purchased immediately.

In order to control my spending on wants, I've come up with the following test for determining when an item or service is really a need.

Ask someone (your spouse, a friend, a sibling, etc) the following question: Based on what you know of my financial situation, is this item (or service) a need, or is this item something that I can live without, at least for now? If they answer that it is a need, you should probably acquire it as soon as possible. If they answer that it is a want, you should probably wait to acquire it until you are in a better financial situation. It's ok to acquire wants, but only after you have a stable financial situation and can afford the item or service.

As I continue to ask my wife this question for each new thing that I think I need, counseling with her will help me keep my priorities straight and keep my spending under control.