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Credit is an enigma to many people.  Everyone knows that your credit score affects your life in more and more ways everyday.  Virtually any type of credit you want or need is granted or denied based on your credit score.  In addition, the rates you will pay for this credit is also affected by your score.  So, how are these myterious FICO* scores computed?

There are 4 types of credit that are scored.

Mortgages - self explantory.  If you own real estate property, you probably have, or once had a mortgage loan.  Assuming this loan was through a bank or credit union, your payments are reported to the credit agencies.  This is one type of credit that is not dependent on the size of the loan, or how much you have paid it down.  The effect of this type of credit on your score relies only on how you pay your bills - on time or not.  If you pay on time every month, a mortgage is very heavily weighted and moves your score up very quickly.  Conversely, if you are late just once, the negative impact is HUGE.

Installment Credit - This would apply to auto loans, for instance.  An installment line of credit is one where you take out a loan for a specific amount, and are expected to pay off this loan over a specified period of time.  Other examples of installment lines of credit could include a gym membership, or other large purchases.  Unfortunately, each time you open a new line of Installment credit, this has a negative impact on your credit score because of a glitch in credit scoring.  This type of credit will have a slightly negative impact on your score until you pay this balance down considerably.  However, making your payments on time can offset the negative impact.

Revolving Credit - This is your credit card or other types of credit where you have a high credit limit, and can charge and pay down at your own choosing.  This type of credit can have both positive and negative effects on your credit that can change monthly, depending on how much you charge, frequency of use, amount of credit limit, and of course, how you pay.  It is always best to keep your balance on any revolving line of credit LOW relative to the credit limit.  Here are some other rules regarding credit cards:

1.  Contrary to myth - Do NOT close lines of credit you are not using.  If you have a credit card with a credit limit of $10,000 and you are not using it, this looks good to credit bureaus, so increases your score. 

2.  Do not open new credit cards everytime a department store offers you 10-15% off on your purchase.  Frequent inquiries into your credit (in order to qualify you for this new credit card) will lower your credit score.  In addition, new lines of credit tend to lower your score, until those lines are well established. 

3.  Always pay your bill on time.

4.  Charge frequently to keep your accounts and credit scoring active, but if possible, pay off those credit cards every month. 

Derogatory Credit-This includes collections, judgments, foreclosures, bankruptcies, tax liens, unpaid child support reports, etc. 

Derogatory credit such as a collection has a HUGE negative impact on your score.  I've seen scores drop 100 points because someone overlooked paying a $15 medical bill, or cell phone bill.  This drop is sudden, dramatic, and can take years to repair, even after this late payment (that turned into a collection) is repaid. 

Derogatory information is also weighted based on how bad that derogatory information is deemed to be by the credit bureaus.  Basically weighting is as follows - the worst listed first:

1.  foreclosure

2.  bankruptcy

3.  child support and tax liens

4.  judgments

5.  collections

There are many types of credit that we all use every month, that is NOT reported to the credit bureaus.  This type of credit is often acceptable as "alternative credit" for those with NO credit scores, but is otherwise not applicable, no matter how well you pay your bills.  This applies to most utility bills, most medical bills, cell phone bills, etc.  However, if you are late even once on any of these types of credit be aware that all these creditors act very quickly in not just turning off your service, but also in filing collections which are reported to the credit bureaus. 

In general, in order to get the best credit scores, you need to have at least 4 lines of credit being reported, or that has been reported recently.  These should include both revolving and installment lines of credit and should have credit limits of $1000 or more.  I know this seems strange, but the bureaus do need to have a basis for scoring you.

Again - I do urge you to get some sort of credit monitoring and credit protection insurance.  I highly recommend the service provided by Costco, but I know there are other good sources out there.  Be very careful about the "free" credit reporting services offered on line.  Many use unconventional methods of scoring, AND you may find yourself tied into an expensive contract you didn't want. 

In a tough economic environment, ID theft is a huge issue.  Also, creditors do make mistakes.  I think everyone knows someone with an error on their credit report - a collection filed against you for something you never bought or owned, or for a bill you paid but that was posted to a wrong account.  Be very diligent in protecting yourself.  It has never been more important!

Be very careful out there, and as always, if you have any questions, please feel free to call any time.