Credit Reports and Scores

by | Jun 22, 2020

Your borrowing reputation is one of your most important qualities as it shows how you’ve handled paying back your debts in the past. For example, to your friends, your borrowing reputation could be based on things like how you gave back your friend’s basketball after borrowing it. Did you give it back in time? Was it in good condition? To financial institutions, your borrowing reputation is your credit history. It’s important to maintain a good borrowing reputation. If you always give everything back on time and in a good condition, people will be more likely to let you borrow more of their stuff. On the other hand, if you have a bad borrowing reputation, people will no longer want to lend things to you and may put more restrictive conditions on loans.

Being a responsible borrower is the key to maintaining a good borrowing reputation. That is, if you make sure you always return everything in time and in a good condition, people will be more likely to trust you. In the case of financial institutions, repaying your debts in time and in full is the best way to gain their trust so they keep lending you money with lower interest. What happens if you deflate the basketball your friend lent you? Studies show that the best way to regain the trust of someone after you make an honest mistake is to repay that someone in full for the damage. In this case, pay your friend back for the damaged basketball and she will be more likely to forgive you, although she might be wary about lending more things to you in the future.

Regaining the trust of a financial institution works in a similar way. If you fail to repay a loan in time, the financial institution will lose confidence in your ability to pay back loans and they will charge higher interests to those with worse borrowing reputations. But if you want the institution to trust you again, make sure you make all future payments in time and in full and they will slowly but surely trust you again. Your borrowing reputation or credit history shows how you handled paying back your debts in the past. For a financial institution, this means the amount of times you’ve had to pay back a credit or loan. Financial institutions let you pay back your loans in small amounts, and the last possible date for you to pay one of these amounts is called a due date. If you pay the full amount before or on the due date, the financial institution will be happy with you. Otherwise, they will start making you pay more.

As we discussed before, your “borrowing reputation” is the quality that lenders will look to the most when deciding whether to give you a loan. When deciding if you are worthy of a loan (creditworthy), lenders look at your credit report, a record of your past borrowing and repaying.

Lenders can’t talk to your friends and family to determine how good you are at handling debt: that’s why they rely on credit bureaus to collect financial information about individuals and create credit reports. In the U.S., there are three main credit reporting bureaus: Equifax, Experian, and TransUnion. Each of those three main credit reporting bureaus (Equifax, Experian, and TransUnion) provides similar credit reports to lenders, although some differences may exist. They make money by charging individuals and institutions who want to have a look at your credit report. The value of information!

For an individual or institution to be able to see your credit report, you must grant them access to it. When you apply for credit, insurance, or rent however, the respective lenders, insurance companies, and landlords gain legal access to your credit report. Others, like your employer, can also request a copy, but they must have your written permission.

A credit report is divided into the following four categories: “personal identifying information”, such as your name, address, and SSN; “record of credit accounts”, such as the date each account was opened and credit card payment history; “bankruptcy filings”, if applicable; and “inquiries”, meaning who has asked to see your credit report. There are limits to how long information stays on your credit report. For example, late payments may show for up to seven years, while bankruptcies may show for up to ten years. They then disappear and are never again included. Other information stays for different amounts of time, usually seven years. You have the right to see your own credit report for free once per year. You can also check it again if a company has denied you something because of your credit report. Any other time you want to check, you have to pay for it.

Credit reporting bureaus don’t know you personally. Therefore, when compiling information about you they might accidentally include information about someone who isn’t you! Errors in credit reports are more common than you may think. About 1 in 5 consumers has something wrong in their credit report. If you think some of the information on your credit report is wrong, first, tell the credit reporting bureau, in writing, what information you think is inaccurate. There are sample letters online. Second, tell the information provider (the organization that provided the information to the bureau), also in writing, that you’re disputing an item in your credit report. Your stock holdings and earnings and information about your social life don’t appear on your credit report.

Having a negative credit history means that there is some prior “bad” information in your credit report. “Bad information” includes late loan payments, bankruptcy, and more. Lenders distrust people with negative credit reports since they are less certain that these people will be responsible and pay back loans on time. A negative credit report can hurt your chances of getting loans, without which you may not be able to buy a home or car! However, the impacts could go even further. It could keep you from getting the job you wanted, landlords might not want to rent to you, and even phone companies might deny you a contract. For credit reports, "time heals all wounds." If you start being a responsible borrower and always pay your loans on time and in full, you will be back on the right track! You have two options to quickly remove bad information in your credit report. First, you can send the lender an offer to "pay for delete." This means that you promise to pay the debt in exchange for having the bad information removed from your record. Second, if you’ve already paid your accounts, you can send a goodwill request explaining why you were late, how you’re a better borrower now than before, and nicely asking the lender to report your account in a better light. Lenders don’t have to do it, but some might!

Unfortunately, there are many credit repair "counselors" who prey upon vulnerable consumers with poor credit scores. These scammers will make grand promises to erase your negative history and improve your credit, but they will ultimately renege on their word and just take your money. Let’s understand how you can spot a credit repair scam. All credit repair companies must adhere to the “Credit Repair Organizations Act”, a federal law that protects the customer and requires credit repair entities to fulfill their obligations to you. If a credit repair company does not understand these terms when you bring it up, they are not to be trusted. Credit repair companies are not allowed to charge upfront fees, or payments before the service is provided. This can be a sign of potential credit repair fraud, but some legitimate companies are also unaware of this condition. Find another counselor or proceed with caution if you encounter upfront fees. You are also entitled to a copy of the Consumer Credit File Rights Under State and Federal Law, which allows you to obtain a credit report and dispute inaccurate information, as well as a contract detailing the services you are paying for. If either of these is not offered to you, take caution. Credit repair scams may encourage you to create a “new credit identity” that hides your previous history. They may offer you a new Social Security Number (SSN) or tell you to apply for a new Employer Identification Number. However, these "new" SSNs are usually stolen numbers from others, and receiving these is a prosecutable offense for identity theft. Don’t let yourself fall into this trap!

Credit reports differ from credit scores. A credit score is a three-digit number calculated from your credit report that reflects how likely you are to repay your debts. It’s a simple metric for lenders to determine if they should give you a credit card or loan without having to go through the full credit report. FICO, originally Fair, Isaac and Company, created the most well-known type of credit score, FICO scores. The scores range from 300 to 850. A higher score is better, indicating that you’ll likely pay all your loans. On the flip side, a lower score warns lenders to stay away from you. A FICO score above 670 is generally considered to be "good." Any score over 740 is considered to be exceptional, while a score below 580 is considered to be very poor. Your credit score basically determines your creditworthiness, that is, the extent to which you’re suitable to receive financial credit. Creditworthy people (or people with better scores) are more trusted by lenders and receive better rates as a result.

Some factors taken into consideration when calculating credit scores include: Payment History, Amount Owed, and Length of Credit History. Payment history is the most important component of credit score calculations. It essentially answers the question, “can you be trusted to pay back borrowed money?” Among the many things involving Payment History, the most important are: how fast you pay your bills, lawsuits related to late payments of debts, and bankruptcies, if any. Credit utilization history, or amount owed, is defined by the amount of debt you have compared to the available lines of credit you have. Lenders will assess the amount of credit you have and how much of it you have used in order to determine how responsible and financially stable you are. Credit reports also take into account: length of credit history, the length of time you have been using your available lines of credit. An account with a long history of fulfilling debt obligations on time will lead to a positive credit score!

Credit reports evaluate the number of accounts held by a person and the rate at which new accounts are opened. Any time you open a new account and apply for a new line of credit, the lender will conduct an inquiry. This may cause a temporary decline in your credit score because it is assumed that you are experiencing difficulties accessing cash. A "hard inquiry," as they are called, can be on your credit report for up to 24 months, but most will stop affecting your credit score after about 12.

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