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Mortgage Basics - How is your credit rating calculated?

by Courtney Ronan

I felt my stomach churn when, while applying for a home loan, the mortgage loan officer uttered those two dreaded words: "credit rating."

The irony is that my report was immaculate. At the tender age of almost-30, I hadn't been around the block of life enough to as yet do serious damage to my credit rating, although I'm sure I could have wrecked my score despite my youth if I applied myself a bit harder while shopping.

Regardless, I was paranoid at what skeletons the loan officer might unearth from my financial closet. Alas, none. But it was a bit scary to see the degree of detail divulged in my report. The department store card I acquired back in 1990, which I used only a few times. The Ohio-based financing organization that appeared on my credit-card bills as the collector of my monthly dues to a Dallas-area health club. The experience was eye-opening and illustrated vividly the importance of maintaining a good credit rating – particularly if you're in the market for a new home.

So what's the point of having a credit score, anyway? It gives your lender a benchmark figure that helps him or her determine the likelihood of your ability to repay your loan. But your score isn't determined by your lender; rather, a credit information provider calculates your score.

Your credit score will probably be a figure that ranges anywhere from about 350 to 900, with higher numbers indicating a stronger standing. Your score is based on only your credit report. All demographic information -- including your age, city of residency, employment, marital status, race, gender and national origin -- are irrelevant in determining your credit score.

When it comes to your credit standing, the "kisses of death" include (surprise, surprise) mortgage foreclosures and bankruptcies, as well as vehicle repossessions. Being late on your electric bill last June is nothing to lose sleep about, provided you paid within 30 days. If being late on your bill payments is a consistent problem for you, however, you may find your reputation (in other words, your "credit history") standing in your way when you attempt to land a home loan.

(For credit reporting purposes only bills 30 days overdue are regarded as late. However, it's wise not to wait until the last moment just in case a check really does get lost in the mail.)

The first time you see your credit report, you'll find listed all of your outstanding debts, including major and minor credit cards, student loans, car loan and all other loans to which you are obligated. In addition, the report will provide your payment history with respect to each one of these debts. Have you made your payments on time? Consistently? Sporadically? Are you in default on your student loans or other loans? While lenders do not expect perfect credit, too many payments 30 or 60 days overdue in the past year or two can sink a mortgage application or drive you into the realm of higher rates and tougher terms.

If you're a first-time homebuyer, you may not be aware that lenders review the diversity of your credit. Do you exist solely upon credit cards, or have you demonstrated responsibility with various types of credit (which will increase your chances of loan approval)?

Have you been knocking at the doors of multiple lenders, asking for their approval but never receiving it? Another factor of which you may not be aware is that each time you approach a lender to obtain a loan, your credit history is subsequently reviewed, and that review goes on your "permanent" record, so to speak – regardless of whether or not you received the loan. If a prospective lender sees an extensive history of these "credit inquiries" on your report, that's likely to send up a red flag and hurt your chances for approval. One exception, however: Any inquiries you've initiated in the 30 days prior to having your credit score calculated will not be reviewed or used against you.

If for any reason you're denied a loan based on your credit rating, don't despair. You can improve your score. The first step is to seek the guidance of a credit counselor who can help guide you through the process of restoring your credit standing. To find a counselor in your area, one of your best bets is to do an online search of community credit organizations.

Many of these organizations are non-profits and will charge you little or even nothing for their services. Some may charge a fee, and you shouldn't necessarily run from those, either. Be forewarned, however: If it sounds too good to be true, it probably is. If the organization promises you instant loan approval after using their services (for a fee, of course), be extremely wary. Credit takes more than the snap of your fingers to restore.

Also, if you are offered a new credit identity, forget it. So-called credit segregation schemes are easy to spot and likely to be illegal, as well.

It takes time and patience, but with determination, you'll do it -- raising your credit score and, ultimately, your chances of achieving your dream of homeownership