Credit plays a significant role in a person’s life. It can affect the amount paid for housing, insurance and other goods, and determine whether they are approved for credit cards, loans and more. However, fully understanding how credit works may be a challenge. A good place to start is to learn the basics of two credit fundamentals: credit reports and credit scores.
The Credit Report
When a lender receives an application for credit, whether it is for a car, a home, a credit card, or any other type of loan, they will order a credit report to determine the applicant’s credit rating, also known as a credit score or FICO score. The report contains the applicant’s Social Security number, date of birth and employment information. It also contains information on:
Credit accounts. Lenders report on each account a person has with them. They report the type of account it is, the date it was opened the account, the credit limit or loan amount, the account balance and the person’s payment history.
Lender inquiries. The report lists both voluntary requests, which are requests a person makes for credit, and involuntary requests, such as when lenders order a person’s report to make them a pre-approved offer.
Public record and collection items. Public record information includes bankruptcies, foreclosures, suits, wage attachments, liens and judgments.
All of this information helps lenders determine a person’s credit worthiness.
Credit Scores and How they are Developed
Lenders use credit scores to determine how likely people are to repay their loans and use credit. The important word is likely, since scores cannot predict with certainty how someone will act.
Ranging from 350 (high risk) to 850 (low risk), a score considers both positive and negative information in a credit report. Late payments lower your score, but establishing or reestablishing a good record of making payments on time will raise a score.
Scores are developed using thousands of consumer profiles. Fair, Isaac, one of the nation’s most widely recognized names in credit rating development, works with three companies, Equifax, TransUnion and Experian, to develop ratings. Tens of thousands of pairs of credit reports are studied and placed into two groups – those with good payment behavior and those with poor payment behavior. The objective is to predict which of the two groups a particular record is likely to be in two years down the road.
Other Characteristics Taken into Consideration
The characteristics used to determine a rating are found on a person’s credit report, but
their credit history is only one of many factors used to establish a rating. Other characteristics include the length of a credit history, the amount of debt a person carries, the number of credit inquiries recently made, and the types of credit a person has, to name a few.
It is important to know what your credit rating is before applying for credit. That way, there are no surprises with the lender’s decision, and it allows the proper steps to be taken in advance if credit repair is needed. To learn more, visit http://www.myfico.com.
If maintaining a good rating is a problem, it may be beneficial to seek help with an outside credit agency. Credit counseling is available for free by contacting The National Foundation for Credit Counseling at http://www.nfcc.org or 800-388-2277.
Written for suite101.com – 2/2010