Credit Report Basics

What Customers Should Know About Their Credit Reports.

According to a survey conducted by the Consumer Federation of America (CFA), “A strikingly high percentage of Americans not only do not understand basic facts about credit reports and scores, conducted a survey of the American public about their credit scores.”

The same CFA poll indicated the following about American credit customers and their knowledge of credit scores:

• Only 2% knew what their credits scores were.
• Only 3% could name the three major credit reporting bureaus in the U.S.
• 50% admitted that they knew little to nothing about credit reports.
• 61% admitted that they knew little to nothing about credit scores.
• 54% had no idea that they must pay a fee to obtain their credit report.
• 55% had no idea that if they maxed out their credit cards their scores would lower.
• 64% didn’t know it was their responsibility to contact their lender about credit report errors.
• The worst was the 27% that thought a credit score measured knowledge of consumer credit not credit-worth.

It’s obvious from this 2003 CFA survey that Americans are lacking when it comes to credit score knowledge in the following areas:

• What is a credit score?
• What’s the purpose of a credit score?
• Who calculates credit scores?
• How it’s calculated?
• What does your credit score affect?

What is a credit score and what is its purpose?

Your credit score is made up of 3 digits that determine an individual’s credit-worthiness.

Who calculates credit scores?

Your credit score is determined by an organization called the Fair Isaac Corporation or FICO. Credit or FICO scores became such an important part of the financial lives of Americans after World War II, when there was a sudden need to extend credit to consumers to revitalize the American economy after a depression in the late 1940s and early 1950s. Banks decided to offer credit to encourage customers to make purchases. Prior to WWII, banks and retailers did extend credit to customers, but that credit was typically based on a handshake. Suddenly, after WWII banks and retailers were seeing a growth spurt in new residents. They wanted them to extend them credit on mortgages and automobiles, but didn’t want to risk that they would never actually be paid.

The answer was internal credit bureaus that were set up by the banks; however they included information such as criminal records, marital status and domestic history, sexual orientation, and other subjective information that didn’t correctly assess credit worthiness. That’s when Bill Fair, and engineer, and Earl Isaac, a mathematician formed the Fair Isaac Corporation (FICO) in 1956. They introduced a mathematical formula that acted as a scoring system and that would universally measure an individual’s credit worthiness. This was how the FICO scoring system was born, and this same mathematical equation is still used to measure credit risk today.

What’s the purpose of a credit score?

Think of your credit score as your key to the financial door of opportunity, and you should think of credit bureaus as the actual door. It’s a strange analogy, but credit bureaus really do act as the gatekeepers to your financial opportunities. It’s their job to evaluate potential credit borrowers. They do this by gathering financial information about each and every one of us from our banks, credit card companies, lenders and the stores we make purchases from. Then when we apply for credit from a lender, bank or credit card company, credit bureaus share this information with them so they can determine if they should lend us credit or not based on the information gathered from the credit bureau, which includes a person’s credit history and an evaluation of their repayment risk.

Within the United States there are 3 credit reporting agencies that gather this financial information - Equifax, Experian, and TransUnion. They all use the same FICO scoring system to evaluate credit risk.

How is a credit score calculated?

FICO’s mathematical equation is not shared with the general public; however it’s believed that credit bureaus take the following 5 financial factors into consideration:

1. 35% is dependant upon your repayment behavior - Do you pay off debt on time, full balance or just minimum payment?
2. 30% weighs on your debt – the outstanding balances on your credit cards, loans and accounts.
3. 15% depends on the length of your credit history – Have you ever had a credit card or loan before?
4. 10% of your credit score is affected by new credit – When is the last time you applied for a credit card or loan?
5. 10% weighs on the varied types of credit that you have – credit cards, personal loans, mortgages, student loans, auto loans and etc.

Credit scores range between very poor 300 and very good 850. Basically, if your credit score exceeds 720 you are considered a low credit risk, which means you have excellent credit. However if your credit score is below 600, you are considered a high credit risk and you will likely have trouble obtaining loans and credit cards due to your bad credit.

What does your credit score affect?

Your credit score or FICO score is recognized worldwide. This means you will be evaluated according to your FICO score whenever you apply for:

• Personal loans
• Mortgages
• Auto loans
• Student loans
• Credit Cards
• Rentals
• Utilities (hydro, electricity)
• Telephone or Internet service

Your credit score will affect every single decision in your financial future.

How to keep your credit score high:

Check your credit report for accuracy – You should and can check your own credit report for accuracy whenever you like. It will not affect or lower your credit score. This is a myth. However sometimes errors exist on our credit reports that negatively affect our credit scores – for example a closed account may still appear open on your credit report. It is up to you to contact the credit bureaus and alert them of the error. Keep in mind that if you file for bankruptcy or default on a loan it will remain on your credit report for between 7 and 10 years. If a decade has expired since you filed for bankruptcy or defaulted on a loan it is up to you to contact all 3 credit bureaus and alert them of the time passed.

Use it or lose it – The best thing you can do for your credit is to use it. Make regular charges on your credit cards and pay off the balance at the end of every month. If you’re using credit actively it appeals to lenders because it’s stable charging activity, just be sure to pay it off on time. If you have multiple credit cards be sure to use each one at least once per month. The key is to keep track of what you’ve charged and pay it off on time.