Credit Histories and Scores
Everyone has a credit history and credit score. If you have never borrowed before, your credit history will be empty. While your credit history and score are both important tools, your credit history may be more important as it lists all of your debts, both past and present, and the condition of your debts. The information contained in a credit history is used by potential lenders to determine if they want to lend more money to you, and at what interest rate.
Your credit history (also referred to as a credit report) contains a summary of how you have borrowed and repaid your debts. A credit report is an up-to-date, objective description of the status of your credit accounts, including but not limited to credit cards, loans, utilities, and rent.
Credit reports contain your personal information including name, social security number, birthday, employers and residences. Any variation of your name that you have used to apply for credit would be displayed in your report as well as any addresses you may have used.
The report lists all of your current and past credit accounts, payment activity, high balance, payment amounts, date of creation, type and status of each account. (Ex: open, closed, paid off, sent to collections, etc.) The accounts would include revolving credit (like a credit card), installment credit (a car loan or mortgage) and show if you are current on payment or past due by 30, 60 or 90 days. The account would display as open, closed, charged off, or in collections. The accounts should also list the name, telephone number and address of your creditors in the event you would need to dispute something on your report.
If you ignore the creditor’s request for payment, and you are unable to work out an agreement to repay or settle the debt, your bill will most likely be turned over to a collection agency. Your outstanding debt may also be sold to a debt buyer, and your delinquency is always reported to a credit bureau. This would be a negative mark on your credit report.
Credit reports may also list certain information of public record such as court judgments, tax liens, foreclosures or bankruptcies.
The information contained in your credit report is calculated into a credit score. While the credit score is important, it doesn’t provide as much detail as your history/report. The credit score provides a very quick snapshot of you as a borrower. Scores can range from 300-850 — the higher the score the better you look to potential lenders. Your credit score tells a potential lender how risky you would be to lend to. If you have a low credit score that can indicate that you are a risk to the lender. If the lender determines to lend to you at all, it may be at a higher interest rate. If you have a high credit score that indicates that you are not very risky to the lender and are responsible in paying your debts. You are more likely to be lent to and usually at a lower interest rate.
Pieces of Your Credit Score Pie
Your credit score is made up of five parts: payment history, amounts owed, length, new credit and types of credit. The five pieces are not equal when determining your credit score.
Payment History (35% of your score)
Your ability to make payments is the biggest component of your credit score. Payment history includes past due items, and how long that payment has been past due. Keeping your payment current will have the biggest, positive impact to your credit score.
Amounts Owed (30% of your score)
The amounts you owe on all of your outstanding credit is the next largest piece of your credit score pie. While having credit and owing money doesn’t mean you are a high risk borrower but rather is helps a potential lender determine if you would be able to handle additional debt. A potential lender understands that if you have too much debt, it may be difficult for you to make payments on an additional debt owed to them and they may decide not to lend to you.
Length of History (15% of your score)
A person must have credit that has been reported for at least six months to even have a credit score. The longer you have had credit established, the more information a potential lender has in order to make a decision about lending to you.
Length of credit takes into account several things:
- How long accounts have been established
- The age of your oldest account
- The age of your newest account
- The average age of all of your accounts
- How long it has been since you used certain accounts
New Credit (10% of your score)
New credits considers the number of new accounts you have and how many times you have recently asked for credit. Every time you apply for credit (ex: credit card, car loan, mortgage, etc.), an inquiry into your credit occurs and is noted on your credit report.
Having a large amount of new credit can indicate that you are just starting to establish credit (coupled with the length of your credit) or you suddenly need to borrow more and that may be a risk to a lender.
Types of Credit (10% of your score)
Diversification of credit is a good thing for your score. Having two or more types of credit will positively impact your score as it shows creditors you are able to handle multiple types of credit. For example, if you have a credit card, a mortgage payment, and a car loan, that can have a positive impact because you are showing you can be responsible with different types of debt.
Since your ability to borrow is directly impacted by your credit report, it is important that you monitor your credit report for accuracy and errors. If you find errors, you have the opportunity to dispute those items and have them corrected. Monitoring your credit score isn’t as important as monitoring your credit history.
If you are denied credit, you are entitled to a copy of the credit report the lender used to make the decision. You must request that report within 60 days of being notified of the denial.
Borrowers are also entitled to one free credit report annually from each of the three major credit bureaus; Transunion, Equifax, and Experian. By visiting www.annualcreditreport.com you can obtain an annual free copy of your credit report from each of the credit bureaus. The information you receive is only your credit report and does not include your credit score. You may receive your credit score by going to CreditKarma.com, or checking to see if your credit card company offers a ‘credit tracker’ option. You should never pay to view your credit report, or score.
The information obtained in each of the reports may differ slightly, but overall they should include the same information. When you review your report you should look for inaccuracies in your personal information, account status information, payment information and ensure all the accounts are yours.
If you find information on your report that you believe is inaccurate, you can contact the credit reporting company and ask that they investigate the items. You will need to inform the company in writing of your dispute. Most of the credit reporting companies have a dispute letter or form you can complete and submit. All items in question must be investigated by the company within 30 days. When the investigation is complete, the credit reporting company must provide you with results of the investigation and a few copies of your credit report.
Responsible Credit Use
Just because you have been approved for a loan or credit card does not necessarily mean you can afford the item(s) you want to purchase with your new credit.
It is up to the borrower to use credit responsibly and wisely. It may be tempting to use your first or new credit card to purchase items that you wouldn’t typically purchase, like an entire new wardrobe or expensive concert tickets. Credit should be reserved for important purchases that you may not otherwise be able to purchase. Items like a home or car are often purchased with the assistance of credit. Higher education is another item that is often purchased using credit.
Smaller, day-to-day items like clothing or food are not the best items to purchase with credit especially if you end up paying interest or finance charges on those purchases. When interest is added to the initial cost of the item, the overall cost of that item can skyrocket. If you do use credit to purchase day-to-day items, it is important to pay those balances in full by the due date to avoid additional charges.
Understanding Credit Cards
Credit Card Terms
The first step to taking control of your personal finances is knowledge and taking control of your credit is the same. It is up to you as a responsible credit user to understand the terms of any credit you have including credit cards.
Before you take on a credit card it is important to understand the details of that specific credit card. The terms and details can vary from one card to another so each offer should be read thoroughly.
The fine print on credit card agreements may seem like a foreign language but if you break it down into pieces, it can make understanding it all a little simpler.
The resources listed below help explain how to read and interpret a credit card’s terms.
- How to read the Schumer Box (the box on your credit card statement that has all the details)
Credit Card Statements
Once you have selected a credit card and used it for a purchase, you will receive a credit card statement. It is important to understand the information on your statement in order to review the statement for accuracy.
The statement will display new purchases, recent payment, previous balance, current balance as well as interest rate and payment information.
Most consumers have established online accounts with their creditors. If you have done this, you may not receive a paper statement in the mail but rather you will have to access your statement via your online account. It is important to know when your payment is due because even if you don’t receive a statement, you are still required to make a payment.
Whether your statement is on paper or online, it’s important to review your credit card statement monthly to ensure you are billed properly. First you must understand your credit card statement before you can determine if you are billed correctly.
The Federal Trade Commission also has information regarding what to look for on your statements and how to dispute any errors.
Bankrate provides a credit card payoff calculator you can use to determine how long until your balance is paid in full or what amount you should pay each month in order to have your balance paid off in a specified amount of time.
Students often think that checking their credit often will lower their score. The truth is there are two types of inquiries that can occur on your credit report –hard inquiries and soft inquiries. While both types of credit inquiries include a third party, such as you or a lender, only hard inquiries can negatively affect your credit score.
A hard inquiry occurs when a financial institution is pulling your credit to make a lending decision. For example, when you go to the bank and apply for a mortgage, you must authorize the lender to pull your credit first before they complete this "hard pull." These hard inquiries can lower your score by a few points, but fortunately, as time passes, the inquiry will fall off your credit report.
A soft inquire occurs when person or company checks your credit report as part of a background check, or a pre-approval for a credit card offering. Unlike hard inquiries, a soft inquiry may occur without your permission. However, soft inquiries won’t affect your score, and are typically not reported.
One of the biggest credit misconceptions is that checking your own credit score using companies like Credit Karma will hurt your credit score. This is not the case. You can check your credit scores at Credit Karma as often as you like without affecting your credit score.