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When you visit a lender to borrow money, do you know how they decide whether or not to lend you money?

The lender types information into their computer and then an answer comes back and they relate the “good news; you’re approved!” or “bad news; you’ve been declined” to us.

What many people don’t know is how they reached that decision. Credit scores are somehow involved… But how? And who provides these credit scores? There is a lot of confusion surrounding the application of a loan so let’s take a closer look at the process to dispel some myths (and reveal some opportunities for you to boost your credit).

The first confusion to clear up is WHO provides credit information: The companies that provide your credit scores to lenders are NOT government agencies. They are sometimes called “credit reporting agencies” or “credit bureaus” but they are for-profit companies, just like McDonald’s or General Motors.

The second confusion to clear up is HOW they collect information: There are three of these credit reporting agencies — Experian, Equifax, and TransUnion — and they each collect information about you from various sources, including publicly available information as well as from information you provide on loan applications. Remember this because their information-gathering systems are not 100% reliable and you might be surprised to discover errors on your credit reports from these companies.

The third confusion to clear up is WHAT they do with the information: The three credit reporting companies do not communicate with each other. They each collect information about you, and compile it into a report — your credit report. When you apply for credit, the credit reporting agency provides your report to the creditor to whom you are applying for credit.

The fourth confusion to clear up is WHY some lenders lend to you and others don’t: When you apply for a loan, lenders take your information and pull your credit report with scores. If you apply for a mortgage they will pull all three credit reports with scores. Then they usually take the middle score (not the top score or the bottom score or the average of all the scores — just the score that’s in the middle) and they compare that to the “ideal” score that the lending company has decided is the minimum score they will lend to. So, if your middle score is at least as high as their minimum score, you’ll likely receive the loan.

With these four misconceptions corrected, the next step for you is clear: If you want to apply for a loan, take steps now to boost your credit by working with all three credit reporting companies to correct mistakes and build your credit so you can have a higher credit score.

Image: www.SeniorLiving.Org, via Flickr

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