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Lots of people have been denied loans, credit cards, or other forms of credit because of inaccurate information lenders find on their credit report. Before a bank (or any other financial institution) grants your application for a loan they will want to find out about your credit history by requesting a copy of your credit report.
As we have already covered, your credit report is a compilation of your credit history, past financial transactions, and your personal information. This report is usually compiled by one of three accredited agencies known commonly as credit reporting agencies. In the United States there are three major credit bureaus, Experian, Equifax, and TransUnion. Credit reporting agencies are corporations that help credit card companies, loan companies, banks, and department stores ascertain the credit worthiness of their customers. The credit reporting agency will provide the lending companies all your information so that the lender can see who is a good credit risk and who is not. The credit reporting agencies receive most of their information from loan companies, credit card companies, banks, and other lending sources. In the report to the credit reporting agency will be information such as your occupation, place of employment, residence records, judgement and arrest records, income status, plus the details on any payments (past and present). Once the reporting agencies have all the detailed information from the lending sources, they give that information out to any organization in need of a credit score (when it is requested of course). They keep information on file concerning you and your credit, but they don’t make any final judgments as to your credit worthiness. The decision of whether or not you receive credit is up to the credit card company or lender you are dealing with. This "credit score" is used by banks, credit card companies, and other financial companies to determine your credit worthiness. Most lenders often based their credit limits and rates on information in your credit report. Some employers often consider information on your credit report before they employ you as well. If you have severe financial problems, some will find it difficult to employ you. Whenever you apply for new credit card, loan, or other form of credit, lenders will base their acceptance or rejection of your application on your personal credit report. If your credit report shows you’ve been reliable in the past, then you will most likely get the credit card or loan you are applying for. However, if you have defaulted on a particular account, or you were constantly late in making payments, it will most likely get your application denied. When compiling your report, the agency itself or a financial institution that’s giving them the information may make a mistake and give inaccurate information about you or your credit. If you do not dispute this error and demand the necessary changes, then the error will get left on your report. You can imagine the possible effects that inaccurate information can have in the future. Because of this very fact, it’s vitally important that you check your reports at least once a year. In order to check your report for any possible inaccurate information, you have to request a copy of your credit report. You can get a free copy of this report from each credit bureau because it’s your credit file and you have the right to know what is in your report. Free credit reports can be found at anuualcreditreport.com.
So now we now that your credit score is the number used in almost every financial transaction that you make (now or in the future). We figured out how is was calculated as well. It’s a good idea to always know what your score is, and understand how lenders will see you as a financial risk. It's also vital to learn how you can improve your score if it is not up to snuff.
Your credit score really just reflects how well you handled the credit given to you in the past. As we already learned, your credit score is determined by the amount of credit you have, how much money you owe, and whether you made payments on time. What most people do not understand is that a lender can only use this "credit score" to determine your risk factor going forward. They have no other data to pull from. Your credit score serves as the only predictor of how likely you are to repay any credit given to you. If your history indicates that you usually make payments on time, you should have a good credit history. This will make it easier for you to get credit cards and loans from banks. But what if your history says other wise? What if your history indicates that you have been irrresponsible with money? In this case, you will find it difficult to get any institution to trust you. If that’s your situation, it doesn't have to be the end of the conversation. Thankfully, I wrote an article on raising your credit score previously. It was entitled, 6 Things That Can Improve Your Credit Score, and I will borrow an excerpt from that article below. These are the 6 most crucial things you can do to increase your credit score right now. 1. Pay on time This is by far the most obvious way to improve your credit score, and it is still the #1 way for improving your score for a big reason. Your payment history makes up a whopping 35% of your credit score. It doesn’t matter if you’re only a few weeks late or a even a few months behind, paying your bills late will always result in a lower credit score. Simply put, don't miss your payments. 2. Pay down debts Your credit score is also comprised of your DTI, or Debt To Income ratio. This is a tricky one to figure out because you have to use your credit in order to build a payment history, but you also want to have your debts paid off at the end of each month. Your credit score is a reflection of how well you manage your credit, but if you pay off your debt completely each time, then you have no credit to manage because you don't owe any money to anyone. The best way to approach this is to pay off your revolving debt each month (credit cards and other high interest loans), but leave a little payment to manage from month to month (small home equity loan or a refinance of old debts). 3. Assortment of credit cards Similar to paying off your debt each month is also showing that you can manage different types of credit cards without a problem. This is not to say that you should have 10 different credit cards, but having a few (2-3 major ones) different credit cards will improve your credit score. Have a Visa, MasterCard, Discover, and an American Express for example. Having multiple cards and credit lines open will show that you can manage your short-term and long-term credit obligations. 4. Delete any errors on your credit report This is the quickest and most efficient method to raise your credit score without doing very much. Correcting any errors on your credit report can raise your credit score 50-100 points very quickly. There is a little time and effort required to do this, but fixing these errors will save you from having to deal with them later on, and it just might boost your credit score. 5. No new credit Once you have a house to live in and an assortment of credit cards for emergency purposes, do not open any more lines of credit unless it is absolutely necessary. It is important that you stay away from getting new credit. Why? Every time you apply for new credit, an inquiry is added to your credit report. These inquiries will drop your credit score by a few points every time. 6. Don’t ever file for bankruptcy or foreclosure Filing for bankruptcy, or having a home foreclosed on, will crush your credit score. Both of these actions stay on your credit report for 7 years. Not only that, but they also decrease your credit score to the point of not being able to improve your overall financial situation. The good news is that over time (3-5 years) a foreclosure or bankruptcy will impact your credit score less and less.
Well then, how is my credit scored there fella?
So now that we know getting approved for any type of loan depends on your credit rating, how does that darn thing get calculated? I actually wrote a detailed article about this some time ago, but the content is worth sharing again here. Your FICO score is really a "how well I pay my bills score" that consists of the following calculations: 35% of your FICO score is based on your payment history. The key points here being frequency of payments (read: whether it was paid on time each month), and most recent occurrence of any non-payment. In other words, all late or completely missed payments will hurt your FICO credit score, but more recently missed payments will have a bigger effect on your score than some older ones. 30% of your personal FICO score is based on credit utilization. This is calculated based on the balance of all your credit accounts in relation to the maximum credit lines available to you. Revolving credit lines (read: credit cards) are the most significant part of this score. Just these two factors comprise 65% of your credit score! That is why I call your FICO score a "how well I pay my bills score". Now for the other 35% of your score. 15% of your FICO score covers your individual credit history. This is based on the number of years your credit has been established (basically the longer, the better). Having just one account 5 years old with consistent payments will look better than 3 accounts all paid off and closed within 6 months. 10% of your FICO score involves what types of credit you have, and the mix of revolving credit inquiries (read: credit applications). This does not include inquiries with no financial rating (Read: an inquiry from a potential employer). As I mentioned earlier, there are three different FICO scores developed by the Fair Isaac Company, one from each of the three major credit bureaus. Experian uses the Experian/Fair Isaac Risk Model, Equifax uses Beacon, and Trans Union has something called Empirica. Consumers are likely to have a different score with each individual agency because each credit reporting bureau has its own set of reporting companies and there will be variations in the credit information that is sent in to them. You should also know that your FICO score ranges from 300 to 850 and suggests an overall general credit profile. What does your general profile mean? FICO score of 720 and above This is a great FICO score, and it suggests that the risk of you defaulting on your credit is very low. If the lender finds any exceptions in your credit report, they will most likely be waived and set aside. If there are any weaknesses in the underwriting your credit (such as not a very long history), your high FICO credit score compensates for that particualr weakness. FICO score 660 to 719 This is good FICO score, and suggests that your risk of default is still relatively low. This FICO credit score indicates that your credit history is acceptable and most people fall within this range. FICO score 620 to 659 This FICO credit score represents a certain amount of risk to the lender. The credit underwriter will more than likely consider you, but will investigate a lot further to check on some details. For example, whether you are self-employed, have a high loan to value ratio, have any cash reserves, or are exceeding normal debt to income ratios. FICO Scores below 640 Anything below 640 is considered sub-prime. Your risk of default is very high, and you will need to present strong compensating factors to the lender before the underwriter would consider approving a loan. Most mortgage lenders will not approve you for a house without at least a minimum 640 credit score. FICO score between 619 to 585. The underwriter will consider approving a loan but that depends on your specific credit issues. You are now in the same class as an applicant with no previous delinquency and lack of sufficient credit history. Mortgage lenders are much more likely to see mortgage delinquencies rise if they loan money to a consumer with a FICO score below 620. FICO score between 584 to 500 You will have to explain your credit history in writing, and will need to pay off most of your debts to even be considered for approval. The loan underwriter may still consider you an acceptable risk but the high risk factors your credit score presents will have a really high interest rate attached to a much smaller credit line. FICO score below 500 This is really bad credit. There may be some serious issues outside your control that caused this financial setback, however. There are also some individuals who simply do not care about what happens to their credit score. This does not mean that the world has ended, though. There is still hope and a way to fix your score. Additional Notes About Your Credit Score: Your credit report changes each month and your FICO score will change as well. Your FICO credit score does not change drastically from one month to the next month, unless there has been a late payment or a negative report hit your account. While late payments, collections, or bankruptcies can be very damaging to your score, it simply takes time to raise your FICO scores back up. It is a good habit to check your credit report every 6 to 12 months. Your credit report must contain at least one reporting credit line over a six month period in order for a FICO score to be generated at all. Your credit report must have one credit line that has been updated in the last six months as well. This will ensure that there is enough information overall, and enough recent information, to accurately calculate your FICO score. Your FICO credit score is meant to be a measure of your creditworthiness to a potential lender. In the mortgage industry, mortgage products and lending terms change constantly. If you manage your credit well, you will certainly qualify for a home purchase loan. In the case of credit cards, your account is reviewed periodically (usually every 6 months), and if you manage your credit well, you will most likely be given higher credit limits and offers to upgrade to a better rewards program. |
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