Borrowing money can be risky for both the lender and the borrower. When you apply for credit, lenders need a way to determine the risk they will be taking if they approve your loan. Credit scoring is the system lenders use to help determine this risk.

While credit scoring methods vary from lender to lender, FICO scores make up the largest part of most credit scoring systems. Your FICO scores are determined by three credit bureaus: Experian, TransUnion and Equifax. Each bureau calculates your score based on information they have on file about you. As this information changes, your credit score will also change.

If your FICO scores are high, lenders will view you as less of a risk. However, no score can truly predict whether you will be a “good” or “bad” customer. There is no single FICO “cutoff score” used by all lenders, and there are many other factors that lenders use to decide whether to lend you money and to determine the terms of your loan.

Because your credit report is so important in this process, you must be certain it is accurate before you apply for a mortgage. You can obtain a free copy of your report every 12 months by calling 877-322-8228 or visiting www.annualcreditreport.com. Check it carefully for mistakes. Up to half of all credit reports may contain errors that can cost a borrower thousands of dollars in interest, or even cause the denial of the loan.

Credit scoring systems usually consider the following information from your credit report:

• Have you paid your bills on time? – Payment history is an important factor. Your score will be lower if you have paid bills late, had an account referred to collections or declared bankruptcy.
• What is your outstanding debt? – Many lenders evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your limit, your score will be lower.
• How long is your credit history? – Lenders also consider the length of your credit track record. An insufficient credit history may have an affect on your score.
• Have you applied for new credit recently? – Your score may be affected by recent inquiries on your credit report. If you have applied for too many new accounts recently, your score may be affected. However, inquiries made by creditors monitoring your account and inquiries you make yourself are not counted.
• How many and what types of credit accounts do you have? – Although it is good to have established credit accounts, having too many credit card accounts may lower your score. Some lenders also consider the types of accounts you have.

Your lender will also consider other factors, including your job or occupation, length of employment, or whether you own a home. A credit scoring system awards points for each of these factors, as well as for information included in your credit report. The total number of points helps predict how likely it is that you will repay a loan and make the payments when due.

Taking steps to improve your FICO scores can make it much easier for you to qualify for a home loan and receive better rates. To improve your credit score, concentrate on paying your bills on time, paying down outstanding balances, and don’t take on any new debt. If your score is low, it may take some time for it to improve.