When you apply for a credit card, mortgage, or even a phone hookup, your credit rating is checked. Credit reporting makes it possible for stores to accept checks, for banks to issue credit or debit cards, and for corporations to manage their operations. Depending on your credit score, lenders will determine what risk you pose to them.

According to financial theory, increased credit risk means that a risk premium must be added to the price at which money is borrowed. Basically, if you have a poor credit score, lenders will not shun you (unless it is utterly awful), but lend you money at a higher rate than the one paid by someone with a better credit score. The table below shows how individuals with varying credit scores will pay dramatically different interest rates on similar mortgage amounts--the difference in interest, in turn, has a large impact on the monthly payments (which pay off both interest and principal):

Credit Is a Fragile Thing

Being aware of your credit and your credit score is very important, especially since you can harm your credit without even being aware of it. Here's a true story of what can happen:

Paul applied for a travel reward miles card, but never received any response from the credit card company. Since it was a high-limit travel card, Paul just assumed that he'd been declined and never thought about it again. Over a year later, Paul goes to the bank to inquire about a mortgage. The people at the bank pull up Paul's credit report and find a bad debt from the credit card company. According to the credit report, the company tried to collect for a year but recently wrote it off as a bad debt, reporting it as an R9, the worst score you can get. Of course, all this is news to Paul.

Well, it turns out there was a clerical error, and Paul's apartment suite number was missing from the address the credit card company had on file. Paul had been approved for the card but never actually received it, and any subsequent correspondence didn't get through either.

So the credit card company still charged Paul the annual fee, which he didn't pay, because he didn't know the debt existed. The annual fee collected interest for a year until the credit card company wrote it off. In the end, after jumping though several fiery hoops, Paul was able to get the problem rectified, and the card company admitted fault and notified the credit-reporting agency.

The point is, even though it was a small balance due (about $150), the administration error almost got in the way of Paul getting a mortgage. Nowadays, since all data goes through computers, incorrect information can easily get onto your credit report.

Tips to Improve or Maintain a High Credit Score:

• Make loan payments on time and for the correct amount.
• Avoid overextending your credit. Unsolicited credit cards that arrive by mail may be tempting to use, but they won't help your credit score.
• Never ignore overdue bills. If you encounter any problems repaying your debt, call your creditor to make repayment arrangements. If you tell them you are having difficulty, they may be flexible.
• Be aware of what type of credit you have. Credit from financing companies can negatively affect your score.
• Keep your outstanding debt as low as you can. Continually extending your credit close to your limit is viewed poorly.
• Limit your number of credit applications. When your credit report is looked at, or "hit," it is viewed as a bad thing.
• Not all hits are viewed negatively (such as those for monitoring of accounts, or prescreens), but most are.
  
• Credit is not built overnight. It's better to provide creditors with a longer historical time frame to review: a longer history of good credit is favored over a shorter period of good history.