In recent years, a three-digit number has become critical to your financial life.

This number, known as a credit score, is a way of measuring an individual's creditworthiness, without requiring access to their income history or employment status.

Credit scoring has been in widespread use by lenders for several decades. Early on, each company had its own credit scoring formula, tailored to the amount of risk it wanted to take, its history with various types of borrowers, and the kind of people it attracted as customers. By the end of the 1970s, most major lenders used some kind of credit scoring formulas to decide whether to accept or reject applications. However most systems were proprietary or used databases of limited size.

In 1989 the Fair Isaac Corporation developed the FICO credit score, which is now the most widely used standard to measure credit risk. The FICO credit scoring formula is based on the biggest lending databases of all – those that are held at the major credit bureaus, which include Equifax, Experian, and TransUnion.

Credit scoring is one of the reasons why consumer credit absolutely exploded in the 1990s. Lenders felt more confidant about making loans to wider groups of people because they had a more precise tool for measuring risk.

Credit scoring also allowed them to make decisions faster, enabling them to make more loans. The result was an unprecedented rise in the amount of available consumer credit.

Here are just a few examples of how available credit expanded during that time:

• The total volume of consumer loans – credit cards, auto loans, and other non mortgage debt more than doubled between 1990 and 2000, to $1.7 trillion.
• The amount of credit card debt outstanding rose nearly three-fold between 1990 and 2002, from $173 billion to $661 billion.
• Home equity lending soared from $261 billion in 1993 to more than $1 trillion 10 years later.

Credit scoring got a huge boost in 1995 when the country's two biggest mortgage-finance agencies, Fannie Mae and Freddie Mac, recommended lenders use FICO credit scores. Because Fannie Mae and Freddie Mac, purchase more than two-thirds of the mortgages made, their recommendations carry enormous weight in the home loan industry.

How Your Score is Calculated – The Five Most Important Factors

The percentages in the chart reflect how important each of the categories is in determining your score. These percentages are based on the importance of the five categories for the general population. For particular groups – for example, people who have not been using credit long – the importance of these categories may be somewhat different.

35% - Payment History – 6 out of 10 Americans don't have a single late payment on their credit report.

• Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)
• Presence of adverse public records (bankruptcy, judgments, suits, liens, wage attachments, etc.), collection items, and/or delinquency (past due items)
• Severity of delinquency (how long past due)
• Amount past due on delinquent accounts or collection items
• Time since (recency of) past due items (delinquency), adverse public records (if any), or collection items (if any)
• Number of past due items on file
• Number of accounts paid as agreed

30% - Amounts Owed – The average American uses 32 percent of his or her available credit limits.

• Amount owing on accounts
• Amount owing on specific types of accounts
• Lack of a specific type of balance, in some cases
• Number of accounts with balances
• Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts)
• Proportion of installment loan amounts still owing (proportion of balance to original loan amount on certain types of installment loans)

15% - Length of Credit History – The average American's oldest account has been established for about 14 years.

• Time since accounts opened
• Time since accounts opened, by specific type of account
• Time since account activity

10% - New Credit – The average American has not opened an account in 20 months.

• Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account
• Number of recent credit inquiries
• Time since recent account opening(s), by type of account
• Time since credit inquiry(s)
• Re-establishment of positive credit history following past payment problems

10% - Types of Credit Used – The average American has four or five bankcards and one installment loan on their credit report.

• Number of (presence, prevalence, and recent information on) various types of accounts (credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc.)

What is Not Calculated in Your Score

FICO scores consider a wide range of information on your credit report. However, they do not consider:

• Your race, color, religion, national origin, sex and marital status.
  US law prohibits credit scoring from considering these facts, as well as any receipt of public assistance, or the exercise of any consumer right under the Consumer Credit Protection Act.
• Your age.
  Other types of scores may consider your age, but FICO scores don't.
• Your salary, occupation, title, employer, date employed or employment history.
  Lenders may consider this information, however, as may other types of scores.
• Where you live.
• Any interest rate being charged on a particular credit card or other account.
• Any items reported as child/family support obligations or rental agreements.
• Certain types of inquiries (requests for your credit report).
  The score does not count consumer initiated inquiries requests – you have made for your credit report, in order to check it. It also does not count promotional inquiries requests made by lenders in order to make you a pre-approved credit offer or administrative inquiries requests made by lenders to review your account with them. Requests that are marked as coming from employers are not counted either.
• Any information not found in your credit report.
• Any information that is not proven to be predictive of future credit performance.
• Whether or not you are participating in a credit counseling of any kind.

What is a Good Score?

FICO scores range from 300 to 850.

One of the first questions many people have about credit scoring is what score lenders consider “good.”  There is, however, no single answer to that question. However, as you can see from the national distribution chart of FICO credit scores, most of the U.S. population has a FICO score of 700 or higher. Many lenders use 700 or 720 as the cutoff for giving borrowers their best rates and terms.

Many also use 620 as a cut-off point. Companies that deal with borrowers below that level are often called “subprime” lenders, because their riskier borrowers are considered less than “prime.”

For a FICO score to be calculated, your credit reports must contain at least one account which has been open for at least six months and has been updated in the past six months.

Why Your Score can Differ?

There is no one score used to make decisions about you. This is true because:

• Your score may be different at each of the main credit reporting agencies.
  The FICO score from each credit reporting agency considers only the data in your credit report at that agency. If your current scores from the credit reporting agencies are different, it's probably because the information those agencies have on you differs.
• FICO scores are not the only credit bureau scores.
  There are other credit bureau scores, although FICO scores are by far the most commonly used. Other credit bureau scores may evaluate your credit report differently than FICO scores, and in some cases a higher score may mean more risk, not less risk as with FICO scores.
• Credit bureau scores are not the only scores used.
  Many lenders use their own scores, which often will include the FICO score as well as other information about you.
• Your FICO score changes over time.
  As your data changes at the credit reporting agency, so will any new score based on your credit report. So your FICO score from a month ago is probably not the same score a lender would get from the credit reporting agency today.

How to Get Your Scores

If you've surfed the Internet lately, you might find it hard to believe that credit scores were secret only a few short years ago. Sometimes it seems like every other Web site is either hawking credit scores or running an ad for a Web site that does.

Beware: Not all credit scores are created equal.

The credit bureaus, for example, sometimes market scores to consumers that aren't based on the FICO formula – the one typically used by lenders. The bureaus say these scores are a good indicator of a consumer's creditworthiness, but their results can differ sometimes markedly from the FICO numbers that lenders use.

Your first step: Make sure you're getting a real FICO score.

For $15.95 Fair Issac Corporation at www.myfico.com offers a product called FICO Standard.

With FICO Standard you can receive one FICO score and credit report from the credit bureau of your choice – Equifax, Experian or TransUnion. Each comes with a full explanation of the score and how lenders view you. Also includes actions you can take to get your FICO score into the higher ranges. Of course, you also have the option of purchasing all three of your credit scores and corresponding credit reports for $47.85.

FYI: Once every year a person in United States is entitled to one free credit report (does not include credit score) from each of the three major credit bureaus. Experian, Transunion and Equifax run a website at www.annualcreditreport.com where you can get your free credit reports.

Improving Your FICO Score

It's important to note that raising your score takes time and there is no quick fix. In fact, quick-fix efforts can backfire. The best advice is to manage credit responsibly over time.

See FICO Score Simulator to get a better idea on how certain actions can affect your FICO score.

Payment History Tips

• Pay your bills on time.
  Delinquent payments and collections can have a major negative impact on your score.
• If you have missed payments, get current and stay current.
  The longer you pay your bills on time, the better your score. If you have lates on your report - contact the creditors that report late payments and request a good faith adjustment that removes the late payments reported on your account. The creditor may work with you, but it may require more than one phone call; patience is required. Your odds of success will dwindle if you're rude or unclear about your request.
• Be aware that paying off a collection account will not remove it from your credit report.
  It will stay on your report for seven years. In fact, paying off a collection account can actually lead to a decreased credit score due to the date of last activity getting updated to the current date when you pay.
  
  Before paying off a collection account contact the collector and request a letter explicitly stating the agreement to delete the account upon receipt or clearance of your payment. Not all collection agencies will delete reporting, but it's certainly worth the effort.
• If you are having trouble making ends meet, contact your creditors or see a legitimate credit counselor.
  This won't improve your score immediately, but if you can begin to manage your credit and pay on time, your score will get better over time.

Amounts Owed Tips

• Keep balances low on credit cards and other revolving credit.
  High outstanding debt can affect a score.
• Pay off debt rather than moving it around.
  The most effective way to improve your score in this area is by paying down your revolving credit. In fact, owing the same amount but having fewer open accounts may lower your score.
• Don't close unused credit cards as a short-term strategy to raise your score.
• Don't open a number of new credit cards that you don't need, just to increase your available credit.
  This approach could backfire and actually lower score.

Length of Credit History Tips

• If you have been managing credit for a short time, don't open a lot of new accounts too rapidly.
  New accounts will lower your average account age, which will have a larger effect on your score if you don't have a lot of other credit information. Also, rapid account buildup can look risky if you are a new credit user.

New Credit Tips

• Do your rate shopping for a given loan within a focused period of time.
  FICO scores distinguish between a search for a single loan and a search for many new credit lines, in part by the length of time over which inquiries occur.
• Re-establish your credit history if you have had problems.
  Opening new accounts responsibly and paying them off on time will raise your score in the long term.
• Note that it's OK to request and check your own credit report.
  This won't affect your score, as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers.

Types of Credit Use Tips

• Apply for and open new credit accounts only as needed.
  Don't open accounts just to have a better credit mix – it probably won't raise your score.
• Have credit cards – but manage them responsibly.
  In general, having credit cards and installment loans (and paying timely payments) will raise your score. Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.
• Note that closing an account doesn't make it go away.
  A closed account will still show up on your credit report, and may be considered by the score.

Facts & Fallacies

Fallacy: My score determines whether or not I get credit.
Fact: Lenders use a number of facts to make credit decisions, including your FICO score. Lenders look at information such as the amount of debt you can reasonably handle given your income, your employment history, and your credit history. Based on their perception of this information, as well as their specific underwriting policies, lenders may extend credit to you although your score is low, or decline your request for credit although your score is high.

Fallacy: A poor score will haunt me forever.
Fact: Just the opposite is true. A score is a snapshot of your risk at a particular point in time. It changes as new information is added to your bank and credit bureau files. Scores change gradually as you change the way you handle credit. For example, past credit problems impact your score less as time passes. Lenders request a current score when you submit a credit application, so they have the most recent information available. Therefore by taking the time to improve your score, you can qualify for more favorable interest rates.

Fallacy: Credit scoring is unfair to minorities.
Fact: Scoring considers only credit-related information. Factors like gender, race, nationality and marital status are not included. In fact, the Equal Credit Opportunity Act (ECOA) prohibits lenders from considering this type of information when issuing credit. Independent research has been done to make sure that credit scoring is not unfair to minorities or people with little credit history. Scoring has proven to be an accurate and consistent measure of repayment for all people who have some credit history. In other words, at a given score, non-minority and minority applicants are equally likely to pay as agreed.

Fallacy: Credit scoring infringes on my privacy.
Fact: Credit scoring evaluates the same information lenders already look at - the credit bureau report, credit application and/or your bank file. A score is simply a numeric summary of that information. Lenders using scoring sometimes ask for less information - fewer questions on the application form, for example.

Fallacy: My score will drop if I apply for new credit.
Fact: If it does, it probably won't drop much. If you apply for several credit cards within a short period of time, multiple requests for your credit report information (called inquiries) will appear on your report. Looking for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from auto or mortgage lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on the credit score.

Fallacy: Closing Credit Accounts Will Help Your Score.
Fact: Many people with high credit scores find that one of the few marks against them is the number of credit accounts listed on their reports. Many erroneously assume they can “fix” this problem by closing accounts. But after you've opened the accounts, you've done the damage. You can't undo it by closing the account.

You can, however, make matters worse. Closing accounts can hurt you in two ways:

• Closing accounts can make your credit history look younger than it is. Your credit score factors in the age of your oldest account and the average age of all your accounts. So closing accounts, particularly older accounts, can ding your score.
• Closing accounts reduces the total credit available to you, making your debt utilization ratio soar. Remember that the FICO formula measures the gap between the credit you use and your total credit limits. The wider the gap, the better. If you suddenly lower that limit by shutting down accounts, the gap narrows and that's a bad thing.

This is true whether or not you keep a balance on your credit cards or pay them off in full every month. Remember: The FICO formula doesn't differentiate between balances that are carried and those that are paid off.

This doesn't mean that you should never close a credit card or other revolving account.

You might want to get rid of a card that's charging you an annual fee or shut down a few unused accounts to reduce the chances they could be hijacked by an identity thief. If your score is already in the mid-700s or higher, you should be fine closing a few accounts as long as they're not your oldest cards. Otherwise, though, you'd be smart just to leave those accounts open.

Fallacy: You Can Boost Your Score By Asking Your Credit Card Company to Lower Your Limits.
Fact: This one is a variation on the idea that reducing your available credit somehow helps your score by making you seem less risky to lenders. Once again, it's off the mark.

Narrowing the gap between the credit you use and the credit you have available to you can have a negative effect on your score. It doesn't matter that you asked for the reduction; the FICO formula doesn't distinguish between lower limits that you requested and lower limits imposed by a creditor. All it sees is less space between your balances and your limits, and that's not good.

If you want to help your score, tackle the problem from the other end: by paying down your debt. Increasing the gap between your balance and your credit limit has a positive effect on your score.

Fallacy: You Can Hurt Your Score By Checking Your Own Credit Report.
Fact: Next to the myth about closing accounts, the myth that you can hurt your score just by checking your credit report seems to be the most pervasive and potentially destructive.

You need to check your credit report and your score fairly frequently to make sure all is right with your financial world. Checking once a year is about the minimum; given the prevalence of identity theft, you might want to check in with all three bureaus at least twice a year. You should definitely pull all three reports and scores a few months before applying for new credit, because it can take awhile to correct any errors you find.

Where you can hurt yourself is if you ask a lender to check your score. When a lender pulls your credit, it generates what's known as “hard” inquiry-and those are counted against your score.

Fallacy: You Can Hurt Your Score By Shopping Around for the Best Rates.
Fact: Creators of scoring formulas know that smart consumers want to shop around for the best rates, particularly on cars and homes. That's why the FICO formula lumps all mortgage- and auto-related inquiries made within 14 days and counts it as one inquiry. Furthermore, any inquiries made in the 30 days before the score is created are ignored. If you do your shopping for a car loan or mortgage in a concentrated period of time and get the loan before the 30-day window is up, you should be fine. Even if it takes a little longer than 30 days to get your loan approved, as often happens with mortgages, you should be okay if your rate-shopping was confined to a two-week period.

Fallacy: Adding a 100-Word Statement to Your File Can Help Your Score If You have an Unresolved Dispute with a Lender.
Fact: While Federal law does give you the right to have such statements attached to your credit file; unfortunately, the credit scoring formula can't read. It calculates scores based on how items on your credit report are coded and these 100-word statements aren't coded at all, so they're not counted.

EMERGENCY! FIXING YOUR CREDIT SCORE FAST

If you're in the midst of trying to get a mortgage, credit report errors can cause serious problems.

Because credit bureaus have 30 days to investigate complaints, you might not have enough time to fix your report before the house falls out of escrow or you get struck with an interest rate much higher than you deserve to pay.

Troubles like these might tempt you to turn to one of the many companies that promise “instant credit repair” or that guarantee to boost your credit score. No legitimate company makes such promises or guarantees, though, so anyone who hires one of these outfits is begging to be scammed.

There are, however, a growing number of genuine services that really can fix mistakes on your credit report in 72 hours or less. Read on to learn more.

Repairing Your Credit in a Matter of Hours: Rapid Rescoring

Rapid rescoring services came about because too many people were losing loans or paying too much interest because of credit bureau inaccuracies. Before you get excited, though, you should learn what these services can and can't do:

• They can't deal with you directly as a consumer – Rapid rescoring is typically offered by small credit reporting agencies, which serve as a kind of middleman between the bureaus and the lending professionals. To benefit from rapid rescoring, you need to be working with a loan officer or mortgage broker who subscribes to an agency that offers the service.
  
• They can help you only if you have proof, or if proof can be obtained – You need something in writing, such as a letter from the creditor acknowledging that your account was reported as late when you were in fact on time. If you don't have such proof, but the creditor has acknowledged the error, some rapid rescorers can get the proof for you. However, that might add days or weeks to the process.
  
• They can help you get errors fixed, but they can't remove true negative items that are in dispute – Again, you need proof that a mistake was made not just your say-so. If the credit bureau is already investigating your complaint about an error, the item typically can't be included in a rapid rescoring process.
  
• They can't promise to help your score – Sometimes removing negative items can actually hurt a score–strange as that might seem.
  

Here's how it works. Your loan officer or broker collects proof from you that a mistake has been made, and he transmits that proof to the credit agency that provides the rapid rescoring service.

The rescorers, in turn, have special relationships with the credit bureaus that allow their requests to be processed quickly. The rescoring service sends proof of errors to special departments at the credit bureaus, and the departments contact the creditors (usually electronically). If the creditor agrees that an error was made, the bureaus quickly update your credit report. After that happens, a new credit score can be calculated.

The cost for this service is typically somewhere between $50 and $100 for each “trade line” or account that's corrected, although some agencies provide the rescoring for no extra charge, as part of a package of services provided to lending professionals.

The availability of rapid rescoring doesn't change the fact that you need to be proactive about your credit. Months before applying for any loan, you need to order copies of your reports and start challenging any inaccuracies. You also need to keep your correspondence about these errors. After all, rapid rescorers typically require some kind of paper trail to follow to prove to the bureau that the mistakes indeed exist.

But if you find yourself in the middle of getting a mortgage and an old problem recurs, rapid rescoring can help you get rid of the problem and save the deal.