If you have ever taken out a loan to buy something—a car, for example—you were given credit. Credit means you are using someone else’s money to pay for things. It also means you are making a promise to repay the money (the loan) to the person or company that loaned you the money (the creditor or lender). Even a credit card is considered a loan as again, you are using someone else’s money to pay for goods and/or services provided. The loan amount usually includes both the principal (the amount of money you borrowed) and interest (the additional dollars you pay for the privilege of borrowing the money). All of this information then gets compiled into your credit report.
What is a credit report?
The important thing to know first is that credit reports do not show demographical information such as race, religion, medical history, personal lifestyle, political preferences, criminal record or any other information unrelated to credit. Credit reports are compiled by national credit-reporting agencies. A credit report does show how much debt you have, your payment history, whether you have ignored credit obligations, and even credit applications for something such as a retail credit card. The typical credit report includes four types of information:
Identifying information: your name, current and previous addresses, telephone number, Social Security number, date of birth, and current and previous employers. This information comes from your credit applications.
Credit information: specific details about your credit cards, student loans, and other loans. This information includes the date opened, credit limit or loan amount, balance, and monthly payment. The report also shows your payment history during the past several years, and the names of anyone else responsible for paying the account, such as a spouse or a co-signer. Late payments, skipped payments, accounts turned over to a collection agencies, and repossession information also appears as part of your credit information. This information comes from loan companies you do business with.
Inquiries: the names of those who obtained a copy of your credit report and how often you have applied for credit in the past two years. When you order a credit report, you may also see the names of companies that have reviewed your report for “pre-approved” credit offers. However, these names will not be given to creditors who request a copy of your report. Creditors only see the inquiries you initiate (by applying for a new credit card, for example). Creditors rely on this information about how you’ve handled your loans in the past to decide how likely you are to repay a new loan. When you apply for credit or a loan, you give the creditor permission to order your credit report from a credit-reporting agency.
Public record information: bankruptcy records, foreclosures, tax liens for unpaid taxes, monetary court judgments (such as lawsuits), and, in some states, overdue child support. This information comes from public records.
There are three national credit reporting agencies: TransUnion, Equifax, and Experian. Each agency gathers the above information and then goes on to calculate your credit score (sometimes called your FICO score) based on the combination of your payment history, outstanding debts, new credit, and credit in use (how much your balance is compared to your available amount). Your score may not be the same at all three agencies because the credit information each agency has about you may be different. This may be because a creditor/lender only reports to one of the agencies exclusively, and it may take a few weeks for the information to become available to the other two agencies. Regardless, your credit score changes when your information changes at any of the credit reporting agencies. Lenders may make a credit card or auto loan decision based on a single agency’s score, although others, such as mortgage lenders often will look at all three scores.
Some credit scores offered to consumers are just estimates and are different from the credit risk scores used by lenders. Consumer reporting agencies and other companies sometimes use an estimated score to illustrate a consumer’s general level of credit risk.
Good Credit versus Bad Credit
Credit or FICO scores range from 350-850 with the average score being in the range of 723. The higher your credit or FICO score, the better your credit.
Good credit means you make your loan payments on time and you repay your debts as promised. Good credit is important because it means you’re more likely to be approved for a new loan in the future when you want to make a major purchase. Lenders feel more confident you will be willing and able to pay back the new loan.
Credit or FICO scores lower than 620 are considered high risk borrowers. And unfortunately, a poor credit score can mean higher car insurance rates, higher interest rates on loans and credit cards, or even a denial in employment, housing or insurance. However, since your credit score changes with the information reported to the credit reporting agencies, this means you can improve a poor score over time by improving how you handle credit. It may take some time, but you will be far better off if you improve your credit before you apply for a home mortgage loan or other large purchase. This is important because if you have a habit of not paying your bills on time, or have a lot of debt, you may not qualify for a mortgage loan. Or the lender may give you a loan, but with a larger down payment requirement or at a higher rate of interest. If you pay a higher rate, you could end up paying thousands of dollars more in interest for your home. For example, an $80,000, 30-year fixed-rate mortgage at 7 percent interest will have a monthly payment of approximately $532, compared with a monthly payment of $644 for the same $80,000 mortgage at 9 percent interest. Over the life of the loan, you will pay close to $40,000 more for the 9 percent loan than you would for the 7 percent loan. As you can see, it may be wise to take care of any credit problems you have before you start looking for a home so you can apply for the best interest rate possible.
How do I know if I have good credit?
Sometimes people think they have good credit. Then they apply for a loan and are surprised to learn there are problems. The best way to find out if you have good credit is to get a copy of your credit report.
How to order a credit report.
The best way to know what your credit report shows is to order one and review it carefully. It’s a good idea to order your credit report once a year to make sure there are no errors on it. You can order your credit report from any of the major credit reporting agencies. When you order your report, have ready your Social Security number, date of birth, current and previous addresses for the past five years, and maiden name, if applicable. You may have to pay a small fee (about $8) to get your credit report. Or your state may have a law requiring credit-reporting agencies to provide you with one or two free reports every year. Credit reports are also free after you have been turned down for credit. However, you must ask the agency that produced the credit report for a copy of it within a specified period of time, usually 60 days. Again, the information on your credit report may vary from one credit reporting agency to another. For this reason, you may want to order a report from each of the three credit-reporting agencies.
How to understand your credit report.
Several types of organizations are available to help you understand your credit report at little or no charge. For example, you can ask for help from the credit-reporting agency that sent you the report, or you can visit a nonprofit credit-counseling organization. You can also get help from lending institutions, credit unions, or local housing assistance agencies in your city or county.
