Credit Reports and Credit Scores – the Basics
Do you know your credit score or what’s on your credit report? Do you know who uses that information and why it’s so important? Your credit score and credit history are two of the most important components of your personal finances. Your credit impacts many areas of your life, including the house or car you’re able to purchase, your credit card interest rate, and even your insurance premiums, among other things. Before you can optimize your credit score, you must learn the basics of credit reports and credit scores. To help you, this article covers the following questions:
- What’s a credit report?
- What’s a credit score?
- Why is my credit score so important?
- What does my credit score mean?
- How do I monitor my credit score?
A credit report summarizes the types and amounts of your past and present credit accounts as well as your credit payment history. The primary types of credit accounts and payments reported include revolving (e.g., credit cards), real estate, and installment (e.g., auto and student loans) loans. Other types of payment histories included in your credit report may be for utilities, cell phones, and delinquent accounts assigned to a collection agency. Your credit report contains additional personal information, including your current and past addresses, bankruptcy filings, tax liens, and civil judgments against you.
Creditors provide three agencies with information about consumers’ credit histories. The three credit reporting agencies that maintain credit record databases are Equifax, Experian, and TransUnion. With your permission, these agencies provide your credit report to legitimate businesses reviewing your credit history.
Lenders and creditors use the information in your credit report to calculate a credit score, which is a numerical rating of your current credit worthiness, as well as an assessment of your credit risk. The higher the credit score, the lower the perceived risk.
Several scoring methods exist, but each uses the same basic factors to compute your credit score. Here are the determining factors in general order of importance:
- Payment history – This is a track record of whether or not you pay your bills on time. One or two payments reported late (typically 30 days past due) can have a significant negative impact on your score.
- Debt Balance – Also known as credit utilization, this factor measures your total debt outstanding against your total credit available. For example, if you have a $10,000 credit line available on your credit card and you have a $1,000 balance, your credit utilization is 10 percent. The more you owe compared to your credit limits, the lower your score.
- Length of Credit History – This factor includes the time since the inception of your first credit account and the average age of your active accounts. The longer a good payment history is, especially with active accounts, the better.
- New Credit or Inquiries – This is whether you have new accounts or if you’ve had recent inquiries after you applied for credit. New accounts or multiple inquiries in a short period of time can negatively impact your score.
- Types of Credit – This is the number of accounts you have open as well as the mix of credit between revolving, real estate, and installment loans. The impact on your score may vary based on the type of lender or creditor concerned.
Credit scores were developed to help creditors predict how likely borrowers are to make their payments. Your credit score is an important consideration when you apply for a mortgage, auto, or student loan. Your score determines if you get a loan, and if you do, your terms of repayment.
The higher your score, the more likely you are to obtain the best rates, terms, and offers from lenders. In the current economic and credit environment, some mortgage lenders have raised the bar for borrowing. A minimum score of 740, considerably higher than two years ago, is needed to obtain the best rate under a conventional mortgage, according to Branch Manager Joe Calzaretta of Home Savings of America. Obtaining a very low mortgage rate can save you thousands of dollars over the life of the loan.
Credit scores also play a major role in credit card applications – many credit card companies use your credit score as the only factor in determining if they’ll give you a credit card. However, not only lenders and credit card companies review your credit history. Landlords, insurance agents, utility companies, cell phone providers, and even prospective employers check your credit history as part of your application process. Your credit score isn’t the sole factor in reviewing your application, but these creditors view it as a strong indicator of your ability to pay your debts and meet obligations in a timely manner. Insurance companies may increase your premiums if you have a low credit score, which is a statistical indicator that you’ll submit a higher number of claims. Utility companies and cell phone providers may require you to pay a deposit if they determine your credit score is below their minimum requirement.
Creditors and credit reporting agencies each use their own complex scoring calculations to compute your credit score. There is no one credit score; however, Fair Isaac Corporation (FICO) and VantageScore created the two most common methods and scoring ranges provided to consumers. Because creditors often use their own formulas, they may calculate credit scores that are slightly different than the ones consumers obtain from credit reporting agencies.
FICO scores range from 300-850; anything above 700 is considered good enough to help you obtain better terms. Although a score below 700 won’t automatically disqualify your application, you may not be able to obtain the best rates, and scores below 660 may prevent you from qualifying for certain credit. VantageScore’s range is from 501-990. A score above 700 is considered good enough that a consumer shouldn’t be denied credit solely based on the score. A score below 700 may prevent you from obtaining credit in certain cases.
Because creditors have different parameters, it’s important to ask your creditor what credit score will obtain the best terms. Depending on a creditor’s requirements and your score, you may decide to get a loan or credit elsewhere.
It’s important to monitor your credit score and the information in your credit report from each of the three reporting agencies, as not all creditors report to all three agencies. This will speed up any application process by helping you determine whether or not you can obtain the best rates and terms before you apply for credit. It will also help you monitor and correct inaccurate information to maximize your credit score. Although most large lenders report to all three agencies, credit reporting is voluntary, and the agencies take no responsibility for accurate or complete information. Ensuring accurate reporting is your responsibility.
You can’t increase your credit score if you don’t know what’s in your report. The Fair Credit Reporting Act states that every consumer is entitled to one free credit report per year from each agency. You may order them all at once or even stagger them throughout the year. The only authorized site that offers free credit reports without the purchase of other services is annualcreditreport.com. For a small fee of six to eight dollars, you can obtain your credit score, which is separate from your credit report. A similar fee applies if you request your report more than once a year from any of the three credit reporting agencies. Contact the respective reporting agency immediately if you discover inaccurate or fraudulent information. Go to the Federal Trade Commission for details on how to dispute inaccurate or incomplete information on your credit report.
Whether you’re thinking about buying a home or car in the near future or just care about your long-term personal finances, educating yourself about credit is a vital step in that process. Now that you understand the basics of credit reports and scores, your next step is to learn how to optimize your credit score.