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Credit scoring is a huge part of the mortgage world.

A given credit score can mean the difference between a 5 percent rate and a 6 percent rate; a conventional mortgage and an FHA mortgage; an underwriting approval and an underwriting denial.

And yet, there's a persistent belief among Americans that "having your credit checked" is a bad thing.

In some instances, yes. In most instances, though, no.

See, not all credit applications are created equal. At least, not in the eyes of the bureaus.

A formal credit pull by a mortgage company is treated differently from applying to get 10% off at Target.  To understand why, let's start with some credit scoring basics.

Credit Inquiries Are A Formal Process

A "credit inquiry" is a formal request to review a person's credit report.

Credit inquires are grouped with other traits into a credit-scoring category called "New Credit". New Credit represents 10 percent a person's complete credit score.  On the scale of 300-850, therefore, credit inquiries represent a tiny portion of a maximum of 85 points to a FICO.

There are many times of credit inquiries, but really only 4 of the set can impact a person's credit score:

1. A credit check for a mortgage loan
2. A credit check for an auto loan
3. A credit check for a credit card application
4. A credit check for a store credit card, or consumer loan

These 4 types are singled out because, in each case, the inquiry is made by the applicant in order to get access to more debt.  Because extra debt increases the probability of default, credit inquiries can sometimes foreshadow trouble.

Even then, however, the risk of default varies by application type.

For example, credit card applications can be more damaging to a credit score than a mortgage application.  This is because credit card debts tend to revolve higher over time versus a mortgage which eventually pays down to $0.

So, all things equal, a credit card application will harm your credit score more than an application for a home loan.

A Credit Inquiry Lowers Your FICO By 5 Points

When compared to the other credit scoring elements, Credit Inquiries is a relative nothing.

In the official FICO scoring model, Payment History and Credit Utilization account for 65% of a score, combined, and the amount of time during which you've had credit to your name accounts for 15%.  These three areas are over-weighted because the bureaus are more concerned with what you've already done with your credit versus what you might do with more of it.

Your credit past is the best clue to your credit future and it's one of two reasons why it's okay to give your social security number to as many lenders as you want. The impact of a credit inquiry is tiny next to the value of being a Model Credit Citizen.

A mortgage credit inquiry is estimated to lower a credit score by just 5 points.

Unfortunately, we'll never know for sure because the very act of examining the credit score causes it to move. In Physics, this is called the Heisenberg Principle.  On MTV, it's called The Jersey Shore Syndrome.  Put a camera on something, and it changes.

The Credit Bureaus Don't Hit Your FICO Twice

The second reason you should shop around with lenders is that -- unlike applying for multiple credit cards -- applying for multiple mortgages won't count as multiple, consumer-initiated inquiries. This is a common thing.

You might apply for 5 credit cards and use them all. You're not going to be approved for 5 mortgages.

As such, the credit bureaus have made it formal policy to permit "rate shopping".  Talk to as many lenders as you want in a 14-day time frame; have your credit checked as often as you'd like; compare rates and fees.  All of the inquiries will be lumped into a single application.

It's good for you and it's good for the bureaus. Your credit scores stay high and TransUnion, Equifax and Experian collect more fees from the banks.

Advice From The Credit Bureaus On Getting Low Rates

To promote rate shopping and to lessen The Fear of Credit Inquiry, the people behind the FICO brand spell out for you the best way to get the best mortgage rates possible:

1. If you want the best rate, you should "shop around"
2. Limit rate shopping to 14-day timespan to keep your credit scores high
3. Mortgage lenders can't give accurate rate quotes without a credit score so give up your social security number

Metaphorically, not letting your lender see your FICO is like not letting your doctor check your blood pressure. You'll get a diagnosis when the appointment is over -- it just might not be the right one.

I did some (more) holiday shopping this weekend and as I stood in the checkout lines, I was repeatedly bombarded by cashiers to open a "free store credit card".

"Would you like to save 10% on your purchase today?"

"No, thanks," I said over and over, but not because I don't want to save the money.  10 percent off can be a good thing.

I turned down the offers because I don't want to hurt my credit score while I am in the middle of a remortgage.

It's a bad idea to open a new credit card account while a mortgage application is in process.  To do anything that can change your borrowing profile can be the difference between a mortgage approval and a mortgage denial.

I put this advice on par with:

• Never quit your job between now and closing
• Never buy a new car between now and closing
• Never match wits with a Sicilian when death is on the line

Opening a new credit card account can be a bad idea because, as each new credit card account is created, your overall credit profile takes a short-term hit.  This drops your credit score at a time when you need it the most.

Think from a lender's perspective: if a person is accumulating new credit accounts, they're very likely accumulating new debts, too.  This is risky credit behavior.

According to myFICO.com, "New Credit" makes up 10 percent of your credit score and includes:

1. The number of new credit accounts created
2. The ratio of new credit accounts to all credit account
3. The category of credit to which the new credit accounts belong
4. The time since the new credit accounts were established

So, a Holiday Shopping-charged credit spree (pardon the pun) can do a lot of peripheral damage to a credit score.

Because lower credit scores represent more lending risk, mortgage applicants with lower credit scores tend to have higher mortgage rates.

And now, they may have higher fees, too.

It's definitely okay to sign up for new credit cards and take advantage of the terrific discounts at the register.  Just be aware of the new credit card account may impact your overall credit score.

If you are not applying for a new home loan in the next six months, there isn't so much to worry about.  Six months is a fair amount of time for the credit bureaus to see that you were not on a credit binge, or that you were not abusing your available credit.

"New" is not so "new" after six months, after all.

But, if you will need a new home loan sometime soon, consider whether saving 10 percent on a $100 purchase is worth paying an extra 0.125% on your new mortgage month after month.  On a $300,000 mortgage, that equates to about $25 per month.

The three major credit bureaus -- Experian, Equifax and TransUnion -- announced that they jointly developed a new credit scoring system called VantageScore.

For mortgage lenders specifically, credit scoring determines the likelihood that a person will default on their home loan and VantageScore attempts to fix two issues in credit scoring:

1. Each bureau uses its own proprietary mathematical formula to derive a credit score
2. Some creditors report to one bureau and not all three, meaning that two of three scores are "incomplete"

This is one reason why mortgage lenders use the middle credit score as reported by all three bureaus.  Not the average score; the middle score. 

For example, if a person's credit scores are:

• Experian: 720
• Equifax: 756
• TransUnion: 688

The mortgage credit score is 720.  The VantageScore system aims to change that. 

Rather than report three separate scores, VantageScore incorporates information from all three bureaus into one report and one score.

Mortgage lenders don't like the VantageScore model because it changes credit scoring from an approximate scale of 350-850 scale to a scale of 500-900.  That may not seem like a big deal, but remember that the 350-850 scale is the entire basis of the mortgage lending risk model.

A mortgage lenders can predict with near certainty how well a 520 credit score borrower will perform on his mortgage versus a 620 borrower versus a 720 borrower. 

If the scoring model changes, the mortgage lending risk algorithms must change, too.  And right now, that will add cost to an industry that's already facing shrinking profits.  As a result, mortgage lenders won't accept VantageScore without putting up a fight.

See, for mortgage lender using the "old" scoring models, there is mountains of correlating the current scoring system to the likelihood of foreclosure. 

And, when I say "mountain" think McKinley, not Jack Frost Big Boulder. 

For VantageScore, there's no such thing.  Lenders have no means to map VantageScore system score to their existing credit scoring model.

With VantageScore, lenders can't predict the likelihood of default and so they won't lend their dollars.  And if they won't lend their dollars, they'll bankrupt.  Unfortunate, yes; but true.

So, while VantageScore the product may help credit bureaus generate more sales, VantageScore the credit model is a mortgage industry non-starter. There's just no reason to use it.

A credit score is a prediction the future. 

Specifically, credit scores predict the likelihood that a person will not make a mortgage payment in the next 90 days. 

The best way to predict a person's behavior over the near-term future, history has shown, is to look at that person's behavior over the recent past.

Like Newton said: An object in motion tends to stay in motion.  If a person is having trouble paying their bills today, they'll likely have trouble paying them tomorrow. 

Credit agencies know that "life happens" and that it's normal to face medical emergencies, divorces, job losses and other events that impair a person's ability to make monthly payments on time.

They also know that if payments are missed this month, it's likely they'll be missed next month, too.  Like Newton said.

And this is why the #1 factor in a person's credit score is Payment History.  It comprises 35% of the score.  It is also the reason why credit scores can improve in time with improved behavior. 

Once a person "catches up" with their monthly payments, it can be representative of credit strength.  Perhaps the medicial emergency is over; or, the divorce is finalized; or, the person found a new job.  After getting current, the credit scoring agencies are likely to treat those missed payments as aberrations.

So, want to improve your FICO after missing some payments recently?  Get current, pay your bills on time, and wait -- time will take care of the rest.

(Image courtesy: Wikipedia)

It happens a lot.  After feeling overwhelmed with credit card debt, a person finally pays their accounts down to a $0.00 in hopes of improving their credit and their cash flow. 

Then, the calls his creditor and cancels his credit card account.  This is a fatal credit scoring mistake.

In our Culture of Consumption, it may seem strange that to cancel a credit card could send your credit score plummeting; it's pretty well known that many people live beyond their means using credit cards. 

For as many people that use credit cards for consumption, there are many more that use credit cards for emergencies.  These types of debtors maintain a very low balances and have large available credit lines upon which to draw in the event of emergency.

Emergencies come in many forms:

• Job loss
• Death
• Illness
• Divorce

And having a "cushion" in the case of an emergency can help a person stay solvent in a time of crisis. 

Let's think like a mortgage lender for a moment.  The relative size of a cushion like this is pretty important to lenders because if things hit the fan, a homeowner with a lot of available credit can still stay current on his mortgage. 

You can bet the lenders care that credit lines are big!  Is it any wonder that 30 percent of your credit score is tied to the cushion?

Utilization of credit is measured by the ratio of (total credit used) to (total credit available).  If a person has 5 credit cards, each with $5,000 in available credit, the total credit available is $25,000.

Now, if that person carries a $1,000 on each of the five card, the total credit used is $5,000 and the total credit utilization is ($5,000)/($25,000), or 20%.  This is considered to be a strong ratio for credit scoring purposes.  An ideal ratio is 35% or less.

For every card cancelled, though, the available credit decreases, pushing the utilization ratio higher.  Closing one card changes the math to ($5,000)/($20,000), or 25%.  Closing two pushes it to 33 percent.  Closing three makes is 50 percent.

When you're done with a credit card, don't close it out.  Instead, use it sparingly.  Maybe buy a tank of gas once a month, or a pack of gum or something.  That way, the credit card company will continue to report that you're active, and your utilization ratio can remain as low as possible.

For nearly every mortgage program, a borrower's credit score impacts either the likelihood of approval, the available interest rate, or both.

A credit score is a statistic. It determines the probability of a borrower defaulting on a mortgage. The second largest factor in calculating a credit score is Extent of Indebtedness, or how much money is owed by the borrower.  It comprises 30% of your overall score.

Extent of Indebtedness in plain English reads:

What is the ratio of your overall credit balances to your overall credit limits?

In other words, are you "maxed out" on your credit cards?

As a general rule, the more you are using of your available credit, the lower your credit scores will be. The ideal percentage of credit balance to credit limit is around 35%.

Anything over 70% can be hazardous.

So, if you are currently carrying high credit card balances, one "trick" to improve your credit profile is to move balances to other cards that have capacity. If you have 4-5 cards at 10% of their credit limit, you can shift your liabilities from the 70% card to the cards that are currently low balance.

"But my 70% card has a 2.9% introductory rate; the other cards are at 18% or more!"

Yes, I know. Remember that my advice here is only in the context of credit score. If you don't need to open new credit in the coming months, I would not recommend increasing your cost of credit as in the question above.

This discussion is only for people who know that they need their credit in the near-term.

By shifting credit card balances among your cards -- even if the rate of payment is much higher -- you can save yourself money month over month.

Consider the following example in which a person is applying for a $300,000 mortgage:

• Credit Card #1: $20,000 balance at 2.9%, $48.33 monthly. Credit Limit is $20,000.
• Credit Card #2: $1,000 balance at 18.0%, $15.00 monthly. Credit Limit is $18,000.
• Credit Card #3: $1,000 balance at 18.0%, $15.00 monthly. Credit Limit is $5,000.
• Credit Card #4: $1,000 balance at 18.0%, $15.00 monthly. Credit Limit is $4,000.
• Credit Card #5: $1,000 balance at 18.0%, $15.00 monthly. Credit Limit is $1,000.
• Total Monthly Credit Card Payment: $108.33
• Credit Score: 640
• Mortgage Interest Rate: 6.75%
• Mortgage Payment: $1,945.79

Now, let's shift some of those credit card balances and re-assess the same situation:

• Credit Card #1: $10,000 balance at 2.9%, $24.16 monthly. Credit Limit is $20,000.
• Credit Card #2: $9,000 balance at 18.0%, $135.00 monthly. Credit Limit is $18,000.
• Credit Card #3: $2,500 balance at 18.0%, $37.50 monthly. Credit Limit is $5,000.
• Credit Card #4: $2,000 balance at 18.0%, $30.00 monthly. Credit Limit is $4,000.
• Credit Card #5: $500 balance at 18.0%, $7.50 monthly. Credit Limit is $1,000.
• Total Monthly Credit Card Payment: $234.16
• Credit Score: 720
• Mortgage Interest Rate: 6.00%
• Mortgage Payment: $1,798.65

Example #2 shows savings of $21.31 over Example #1 because the higher credit score resulted in a lower mortgage interest rate. There is no reason why a person cannot re-shift all of their credit debt immediately after their mortgage closing.

By having a higher credit score, a homeowner not only has access to lower interest rates, but also has access to more types of mortgage products. This, too, can result in lower monthly payments with the help of a mortgage professional.