The record of how your bills are paid is summed up with your credit file. Those with good credit are rewarded with low borrowing costs. Those with no, limited or poor credit, pay the price through loan declines and high interest rates. Given its importance and the need to establish and maintain credit, here are the top 12 things you must know.
Credit Scores and Reports Are Two Different Things but they work in conjunction with each other to illustrate credit worthiness. A credit report is maintained by three bureaus (Experian, Equifax and Trans Union). They report payment history, loan balances, requests for new credit, and other pertinent information about you and your bill paying habits. A credit score is a three-digit number that tabulates the data points found on your report to reflect your risk to a lender.
Credit is All About Accessing Risk. Credit scores and reports were established giving banks consistent benchmarks to measure consumer credit worthiness. The question the report and score answers is this: ‘Will you repay the bank their loan.’ Late payments and high balances create concern over whether you will be able to pay new credit if it is extended.
Loans Are Approved and Denied Primarily Based On Credit. Applications gather a personal information including income, time in your home, and job stability. However, constancy in those areas cannot overcome poor credit scores. Today, many lenders use automated systems that conditionally approve or deny based on a few key factors, including your credit score. Denials are often not reviewed by a human, even if your qualification is just under the lender’s threshold. Credit cards and other ‘instant’ approvals are strictly automated by a computer.
Terms and Interest Rates Are Largely Determined by Credit Score. So while your score may be high enough to get approved, this number will also be used to decide what terms and rates you will be offered. The higher your score, the lower the rate you can acquire. High credit scores can benefit from single digit credit card offers and high credit limits.
More Than Just Lenders Use Credit to Determine Qualifications. Landlords use credit along with back ground checks to determine approval. Cell phone companies, utilities and cable providers use credit scores to decide if you need a down payment or deposit. Employers frequently use credit scores and reports before employment offers are made. Car insurance companies use credit scores when quoting rates.
Credit Score and Credit Report Companies Are for Profit Organizations. While they receive government oversight, they are not operated by a government agency. Credit bureaus are in the business of gathering client information and reporting it as they receive it. Credit score companies like FICO, are in business of evaluating those data points and creating a score that represents the credit merits of the consumer. They sell these reports and scores to other companies who want to evaluate the worthiness of your application.
Errors Happen and Can Be Fixed. Much of the reporting and scoring systems are now automated which has reduced errors. However, if the lender reports misinformation to the bureau, that information goes on your credit file. Errors can impact your ability to get the most favorable terms. It is your responsibility to find and fix errors on the reports, which means you must track your own credit to ensure its accuracy.
Free Reports and Scores Are Available. Due to the importance of a credit file, consumers are able to obtain a free copy of your credit file from each bureau once every 12 months. Credit scores are typically offered free from credit card companies and can be tracked each month. Credit scores offered by your credit card companies do not include the full report.
You Don’t Have to Go in Debt to Establish Credit. While debt accumulation is the most common way to establish credit, it is not required. The credit reports include all credit accounts. Loans for your home, car, and credit cards are reported each month. Credit cards that are paid in full each month, do not incur debt, but are still reported on the credit file, assisting you with building and maintaining your credit.
Not All Bills Are Reported. Banking account activity and debit card usage is not reported on your credit file. In the same token overdrafts are not reported on this system either, though if you leave an account in the negative a collection will be reported. Other accounts that are absent from your credit file include, private loans, utility payments, rents and cell phone bills. Title loans and payday loans are also not typically reported.
A Few Key Factors Determine Your Credit Score. Credit scores are offered by a number of different scoring companies. Each uses a different scoring range, parameters, and proprietary algorithms. FICO, the credit score used by 90% of lenders, ranges from 300 to 850, and establishes its score from five key factors.
- Payment History is the single biggest factor making up 30% of the credit score. This puts the main emphasis on paying bills by the due date. A single late payment will impact this number significantly because of its high percentage. Multiple late payments, collection accounts and other defaults will keep your score low.
- Utilization is considered your total balances compared to your available credit on revolving accounts. Maxing out credit cards will impact the score by 30%. It is recommended that you keep balances on revolving accounts between 30% and 50% of the available limit.
- Credit History focuses on how long you have had credit accounts open, and accounts for 15% of your score. Leaving older accounts open will benefit you, even if they are only used periodically.
- Credit Mix accounts for 10% of the score and includes the number of fixed loan accounts versus revolving accounts. Having both will help build your score. It also means getting a new car loan or mortgage will not generally impact your score negatively.
- New Credit tabulates the number of new open accounts along with the number of times you apply for credit. Each time you complete an application a ‘hard’ hit is made on the report and can impact your score. ‘Soft’ hits do not impact your score and come from companies who view the report for account maintenance or making a credit offer.
Improving Your Score Takes Time. Any negative data remains on your report for seven years. The further away the discretion is, the less it impacts your score. A late payment 5 years ago will still show but will not be counted as heavily as one made in the last 12 months. Removing errors can improve the score, along with paying bills on time, and not applying for new credit.
Credit is like your financial report card. It communicates to companies how you manage money. It does not take your personal circumstances into account, or play favorites. The score is simply a financial calculation that has a direct impact on your life. Good money management will lead to a higher score and lower costs on many fronts.