Understanding & Improving Credit

Lenders, employers, landlords, and other service providers obtain your credit information in the form of a credit report to help them decide whether to approve your application for a loan, credit card, job, or housing. For many service providers, the decision to offer you a product or service at a particular cost is based on the details found in your credit history.

With much of your personal information available to these providers, it’s important that you have access to the information shared about you. You want to know the information is accurate and have the opportunity to refute any errors in your credit history.

All consumers are eligible for one free annual credit report. It’s recommended that you review your credit information regularly to check its accuracy since credit files change often. Knowing what’s in your credit report is only half the story; your credit score is the best indicator of the overall health of your credit.

What Information is Included in Your Credit Report?

Personal information is compiled from credit applications you’ve completed. This information normally includes your name, current and recent addresses, Social Security number, date of birth and current and previous employers.

Your credit history consists of details about credit accounts that were opened in your name or that list you as an authorized user (such as a spouse’s or parent’s credit card). Account details, which are supplied by your creditors, include the date the account was opened, the credit limit or amount of the loan, the payment terms, the balance and a history that shows whether or not you’ve paid the account on time. Closed or inactive accounts, depending on the manner in which they were paid, stay on your report for 7 to 11 years from the date of their last activity.

Credit inquiries are recorded whenever your credit report is requested by another party, such as a lender, service provider, landlord, or insurer. These inquiries remain on your credit report for up to two years.

Public records are obtained from government sources such as courts of law. Matters of public record – including liens, bankruptcies, and overdue child support – may appear on your credit report. Most public record information stays on your credit report for 7 years.

What is a Credit Score?

A credit score is a numerical rating used by a lender to help determine whether or not you qualify for a particular credit card, loan, or service. The credit reporting agencies apply certain risk factors to the information in your credit file to yield your credit score. Credit scores estimate the risk a company incurs by lending you money or providing you with a service – specifically, the likelihood that you’ll fail to make payments in the next two to three years. Credit scores generally range from 300 to 850. The higher the score, the less risk you represent to the lender.

While consumers can receive a free credit report once a year through www.annualcreditreport.com, credit scores are not included. It’s a good idea to purchase your scores through this website for the three credit reporting agencies – Equifax, Experian, and TransUnion. They each have a slightly different mathematical model for scoring and may actually have different information for one or more of your accounts. It’s not uncommon for your three scores to differ by 20 - 30 points. A higher difference in scores may mean one or more bureaus have incorrect information or that certain information was not reported to all three bureaus.

Top 7 Factors that Affect Your Credit Score

Each of the credit reporting agencies weighs credit factors differently, but most credit scoring models are based on the following factors:

Payment history. This, along with public records, generally accounts for approximately 35% of your credit score. A record of late payments on your current and past credit accounts will typically lower your credit score.

Public records. Matters of public record such as bankruptcies, judgments, and collection items will lower your credit score, but will have less negative impact with each subsequent year of good credit.

Length of credit history. In general, a longer credit history is better and can sometimes have a positive impact on your score. Credit history typically accounts for around 15% of your credit score.

New accounts. Opening multiple accounts in a short period of time may negatively impact your score. It is better to keep unused credit cards open then to open a number of new credit accounts.

Inquiries. Whenever someone else requests your credit report – a lender, landlord, or insurer, for example – an inquiry is recorded on your credit report. A large number of recent inquiries may negatively impact your score. Your new credit accounts and inquiries generally make up about 10% of your score.

Accounts in use. The presence of too many open accounts can have a negative impact on your score, whether you’re using the accounts or not. This activity usually makes up approximately 10% of your score.

Amounts owed. A high balance relative to the limit on an account may negatively impact your score. It’s preferable to show that you’re not maxing out the credit available to you. Keeping your balance on each revolving account below one-half of the limit may increase your score. Approximately 30% of your score is based on this category.

How Can You Improve Your Credit Score?

If you’ve had poor credit performance in the past, credit scoring doesn’t let that haunt you forever. The impact of past credit problems fades as time passes and as recent good payment patterns show up on your credit report. Even if you’ve had a satisfactory payment history, taking steps to improve your FICO scores can often help you qualify for better rates from lenders.

Your scores will improve over time by managing your credit responsibly and by following these credit basics:

Obtain your free credit report annually from the three credit bureaus by visiting www.annualcreditreport.com to confirm that the information in your credit report is correct. Have incorrect or erroneous information updated.

Pay down high credit card and revolving account balances, but don’t close the account. If possible, keep your balances below 30% of the limit on your account. When your balance is paid off, use the account every few months for a small item that you can pay in full the following month. This will keep the account “active.”

Avoid moving credit balances from one account to another just to take advantage of low introductory interest rates. The combination of “inquiries” and “new accounts” can negatively impact your score.

The best repair for serious credit issues such as bankruptcies, liens, and collections is to re-establish credit accounts. This might be through your bank with a “secured” credit card; when you demonstrate your ability to be responsible with your payments , you can ask for an unsecured card with possibly a higher limit. Remember to keep your balance low so you can pay it in full each month.

If possible, avoid “finance company” type credit accounts. Mortgage loans, installment loans and revolving credit card accounts impact your score more favorable than finance company accounts.

When you’re applying for financing, such as a mortgage, having a credit history is important. While it’s admirable that some people have the discipline not to purchase what they can’t pay for in cash, this doesn’t translate to a “credit history.” When these individuals purchase a high-ticket item such as a car or home that requires a loan, there is no history that can feed into a credit score, and these people are at a disadvantage. It’s true they haven’t purchased what they couldn’t afford, but they have also not been able to show that they can handle revolving credit and on-time payments. Having a credit history—and credit scores--often allows lenders to make “instant credit” decisions in a fast, objective way.