About Your Credit

Credit Tips

I’m often asked by clients to explain how this whole “credit” thing works.  It’s a good question considering it is typically the single most important factor when trying to obtain a loan.  A few negative points could mean a higher interest rate, or even the loan.

What is a credit bureau and what does it do?
A credit bureau is a clearinghouse for credit history information.  Credit grantors (those lending the money) provide the bureau with factual information on how their credit customers pay their bills.  The bureau assembles this information, along with other public record information obtained from courthouses around the country, into a file on each consumer.  In return, credit grantors can obtain credit reports about consumers who wish to open accounts with them.

What is a credit score?
A credit bureau score is one of many pieces of information that a lender will use when evaluating a loan application.  A credit score is a summary of a borrower's credit report and a numerical measurement that reflects a borrower's management of credit.  Your credit score is based on the records compiled by credit bureaus and includes the information reported each month by your creditors, such as the amount of existing credit you have and your payment history.  A credit score considers all of the information in the credit report and converts this information into a number that helps the lender determine the likelihood that you will repay your loan on time.  200 is typically the lowest possible score, 850-900 the highest.  700 or above is considered excellent, and less than 620 is usually considered sub-prime, though if there are errors on the report, this would be considered. 

Credit scoring is an objective process, based only on the information in your credit report.  Factors such as age, race, religion, gender, national origin, marital-status, your income, employment, and where you live are not considered in determining your credit score.

Why are credit scores used?
Lenders want to extend credit to people who will pay them back, and pay them back on time.  They also want to be objective in making lending decisions. In order to approve your application for a mortgage loan, your lender must evaluate and understand many different risk factors, including your ability to repay the debt as well as how you have managed credit in the past.  Because borrowers' credit histories can range from being very simple to being very complex, it is sometimes difficult to determine whether a given credit history is acceptable or unacceptable, or whether certain information represents a strength or a weakness.  

By using credit scoring, lenders can quickly and objectively evaluate your credit history in a consistent manner, and determine the likelihood that you will repay the loan as agreed. The use of credit scores not only improves the accuracy of the analysis of your credit history, but does so in a way that enhances the efficiency and consistency of the underwriting process.

How does a lender get my credit score?
When you apply for your loan, you will give your lender permission to check your credit history with the various credit bureaus. More than likely, the lender will obtain your files from the major credit bureaus: Equifax, Trans Union, and Experian. In addition to obtaining a credit report, the lender will also request a credit score. Your score is calculated by the credit bureau -- not your lender -- and is based only on the information contained in each of the credit bureau's files.

How is my credit score determined?
A credit score is based on information in your credit report, including information about how you have handled debt and credit accounts in the past. The calculations that make up a credit score are developed by looking at the way millions of consumers manage their credit. Credit scores have proven over time to be a reliable indicator of whether or not a consumer would repay a loan. A score is determined by summarizing a number of factors in your credit report. Including:

PAYMENT HISTORY.  How have you paid your debts?  Do you have a long history of paying obligations on time or do you often pay late?  How you paid your bills in the past gives the lender some indication of how you can be expected to pay them in the future.

OUTSTANDING DEBT.  How many consumer loans and open charge accounts do you have?  What are the current balances on these accounts?  The lender wants to know how much credit you have and how much you have used.  Research has shown that the number of credit accounts you have as well as how much of your available credit is used is important. 

CREDIT HISTORY.  How long have you had credit?  Generally, the longer you have had and have successfully managed credit, the higher your credit score.  However, people with relatively new credit histories or those with only one or two accounts can obtain high scores as well.  If you have recently established credit or have only a few credit references, that does not mean that you cannot get a loan.  Working with your lender, you may be able to establish a "nontraditional" credit report that is based on how well you have paid other types of debts, such as rent and utility payments. 

CREDIT INQUIRIES.  How many times have you authorized a lender to check your credit record?  How many new accounts have been opened recently?  Every time you apply for credit for an automobile, consumer loan, to open a new charge account, etc. the lender checks your credit history with one of the credit bureaus.  This is called an "inquiry" and is recorded in your credit report.  Sometimes, having many inquiries within a recent period on your file indicates that your credit usage may be increasing and creates an additional level of risk for the lender. 

TYPES OF CREDIT.  What types of credit do you have in use?  Do you have a mixture of types of credit, such as credit cards, personal loans, etc.?  Your credit score is calculated based on your history in these and other areas.  Having established credit, paying your bills on time, and keeping the balances on open accounts to moderate levels will help ensure that you have a strong credit history and a good score.

The three major credit bureaus are: