|
What Is a Credit Report?
A credit report is a report from a credit bureau containing
detailed information bearing on credit-worthiness, including an
individual's credit history.
A typical credit report includes the following:
• Personal information: This is to identify the
individual, hopefully distinguishing him or her from every other
individual on the planet. It includes Social Security number, current
and past addresses, and current employment.
• Information from public records (states and
counties): This includes liens, garnishments, foreclosures, bankruptcies,
law-suits, and judgments.
• Information from collection agencies: This
consists of past-due debts that have been given to collection agencies
to collect.
• Information from creditors: This includes the
identity of the creditor, the date the relationship began, the current
status of each account including the amount outstanding, the maximum
line if any, the current status of the account, and any past delinquencies.
• Information about inquiries: This identifies
companies that have requested the individual’s file within
the last two years, distinguishing those authorized by the consumer
and those not so authorized. Only the former affect credit scores.
There are three major repositories of credit information:
Equifax, Experian, and TransUnion. The information provided by the
three is not exactly the same because not all credit grantors report
information to all three.
At one time, underwriters with responsibility for
determining whether or not a mortgage applicant was "credit
worthy" spent much of their time studying and interpreting
credit reports. Increasingly, however, this judgment is being based
on credit scores, which are derived mechanically from information
in the credit reports. Credit scores are discussed later.
Errors in Credit Reports
The credit reporting system is imperfect. Credit grantors,
which are the source of much of the information that goes to the
three credit bureaus, make mistakes. Some are due to sloppiness,
some to confusion over names, and some are intentional. Some lenders
deliberately withhold information on timely payments and maximum
credit lines to prevent a customer’s credit score from rising,
because it might result in losing the customer.
The credit bureaus also make mistakes. They have no
financial interest in keeping anyone’s credit score low, but
they do have a financial interest in managing their enormous databases
at the lowest possible cost. The more common your name, the higher
the probability that your file contains information pertaining to
someone else with the same name -- and that information about you
has been inserted into someone else’s file.
Errors from credit grantors and credit bureaus are
of both omission and commission. An error of omission is a piece
of information which should be in your file but isn’t. An error
of commission is the placing of information in your file that doesn’t
belong there. Whatever the source, errors can adversely affect your
credit report. The last section in this column is a guide on how
to remove errors.
What Is a Credit Score?
A credit score is a measure of your credit worthiness.
The most common credit score is called the FICO score because it
was developed by the Fair Isaac Company. The higher the FICO score,
the greater the likelihood that the debts of the borrower will be
repaid on time.
FICO scores range from 350 to 850. According to Fair
Isaac, the median score over the entire population is about 715,
with 20% above 780 and 20% below 620. The minimum score required
to qualify for the lowest mortgage rate is about 740, but it varies
from lender to lender, and often depends on other characteristics
of the transaction.
Credit scores have speeded up the process of making
loan decisions, and have largely eliminated personal bias and subjectivity
in the decision process. The major downside is the possibility of
data error. FICO scores are based entirely on information taken
from credit reports. If the credit report is contaminated by erroneous
or incomplete information, the FICO score will also be contaminated.
In 2006, Equifax, Experian, and TransUnion set up
a rival credit scoring system, VantageScore, in competition with
Fair Isaac's FICO. VantageScore uses a scale that ranges up to 1,000,
with 900-1,000 representing an "A" credit, 800-900 a "B,"
and so on. This type of ranking is akin to that used in academic
tests, which may make it intuitively more appealing to users. On
the other hand, having two different scaling systems could result
in confusion. A score of 750 is an "A" with FICO but only
a "C" with VantageScore.
Will Time Improve Your Credit Score?
The Federal Fair Credit Reporting Act puts time on
your side by setting limits on how long negative information can
appear in consumer credit records. Once a piece of information has
been on a consumer’s record for the prescribed period, it's
supposed to drop off. Once off, it will no longer affect your credit
score.
The prescribed periods are as follows: inquiries about
you from credit grantors, 2 years; late payments, mortgage foreclosure,
collection accounts, and Chapter 13 bankruptcy, 7 years; Chapter
7 bankruptcy, 10 years; unpaid tax liens, forever.
Even before negative information drops off a credit
report, credit scoring will give it lower weight as it ages. However,
this doesn’t do borrowers any good unless they generate new
positive credit information. Old bad stuff plus recent good stuff
generates a rising credit score. Old bad stuff followed by no credit
activity results in a continued low score.
Will Paying Delinquent Accounts Improve Your Score?
No. Delinquencies reduce your credit score because
they're viewed as evidence of a weak commitment toward meeting your
obligations. This evidence of your attitude toward debt is not wiped
away when you repay the delinquent loans. They stay on your record
for seven years. However, their weight in your credit score gradually
declines with the passage of time, provided your recent payment
record is better.
Do Credit Inquiries Hurt Your Credit Score?
Credit inquiries reduce credit scores because credit
scorers have found that multiple inquiries are associated with high
risk of default. Distressed borrowers often contact many lenders
hoping to find one who will approve them.
But multiple inquiries can also result from applicants
shopping for the best deal. To avoid catching shoppers in their
net, credit scorers ignore auto and mortgage inquiries that occur
within 30 days of a score date. To avoid biasing the credit score
from earlier shopping episodes, the scorers treat all auto and mortgage
inquiries that occur within a 14-day period as a single inquiry.
The upshot is that credit inquiries will not significantly
impact your credit rating if you do all your shopping in a short
period. Since the market can change from day to day, this is the
only effective way to shop anyway.
Consumers shouldn't be concerned about inquiries they
make, such as ordering a credit report. Self-inquiries don't affect
the credit score. Neither do inquiries from your existing creditors,
potential employers, or businesses considering whether or not to
solicit you. The only inquiries that affect your credit score are
those by new credit grantors that you have explicitly authorized
to check your credit.
How Much Debt Is Too Much?
The two major components of a credit score, which
on average account for two-thirds of the total score, are payment
history and amounts owed. Where the first is a record of how well
you've met your obligations over the years, the second is a snapshot
of your indebtedness right now. If your credit history is short,
your current indebtedness can be the most important factor determining
your credit score.
The approach that FICO credit scorers use to determine
whether you're living beyond your means is to compare the outstanding
debt on each of your accounts with the maximum amount of debt that
the credit grantor has set for you on that account. This generates
a set of "utilization rates" for each of your accounts.
For example, if you have two credit cards with maximum
balances of $4,000 and $5,000, and if the actual balances are $3,000
on both as of the most recent date of record, the utilization rates
are 75% and 60%.
In general, the higher the utilization rates, the
lower the FICO score.
(Note: Don't run out tomorrow to open some more lines
so your balances can be spread over a larger number of accounts.
The FICO genie has a strong distaste for multiple new accounts in
a short period of time, which can be an indicator of financial distress.)
Consumers should be aware of potential problems in
connection with the utilization rates that affect their credit score.
The data on debt balances as reported by credit grantors isn’t
always correct. Furthermore, for various reasons, credit grantors
do not report maximums on all revolving accounts. Where no maximum
is reported, the largest balance ever to be reported on the account
is used in its stead. Since the highest balance is below the maximum,
often substantially below it, this necessarily results in higher
utilization rates for such accounts.
Before going into the market, it's a good idea for
consumers to check their balances and their credit limits. If an
account has no reported limit, you can either ask the credit grantor
to report the limit, or terminate the relationship. In the unlikely
event that the credit grantor won’t report the limit but you
want to maintain the relationship anyway, you can shift all your
balances into this account temporarily so that the highest balance
comes closer to the unreported maximum, then quickly reduce them.
What Is a Delinquent Payment?
A delinquent payment is one that is 30 days or more
past due. This is not the same as a late payment, which is one received
beyond the grace period granted by the lender. If a mortgage payment
due on the first of the month is received on the 20th, for example,
it's late and will incur a late charge, but it isn't delinquent
and will not appear as such on the credit report.
Don’t Try to Skip a Mortgage Payment
A single skipped mortgage payment can mushroom into
a cascade of delinquencies if you don’t cure it immediately.
Under the accounting rules used for amortized mortgages,
lenders always credit a payment against the earliest unpaid obligation.
If you skip your payment in April, you'll record one delinquency.
If you make your payment in May, it will be applied to April, making
you delinquent for May as well. When you make your payment in June
it's applied to May, making you delinquent for June. The delinquencies
accumulate until the skipped payment is made good.
Removing Errors in Credit Reports
It's a good idea for consumers to check their credit
well before they go into the market. This will give them time to
get any errors fixed. Give yourself a minimum of three months.
If you find an error, use this form to contact the
credit reporting agency that reported it. If you follow the instructions
exactly, the agencies are obliged by law to act on your complaint.
|
