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.