Just as a letter grade in school determined your academic fitness, your three digit credit score determines your financial fitness. The credit score, which ranges from the lowest score of 340 to the highest at 850, determines the rate of interest you pay for everything from student loans to mortgages, car loans and credit cards. Your credit score can even determine what kind of job you can accept. Credit reporting is a process in which consumer agencies, banks and credit unions score individuals and determine their credit profile. When planning for your financial future, it’s important to know how credit reporting works.
In the United States, there are three agencies that maintain credit information. Those agencies are TransUnion, Equifax and Experian. These agencies maintain a history of timely debt payments on individual borrowers. This information is in turn used by insurance agencies, loan companies, and employers. They also maintain other public records such as bankruptcies, liens and judgments. The three credit reporting bureaus don’t determine whether you are extended credit or on what terms. They provide the information that lenders and other institutions use to determine a borrower’s creditworthiness. There are several major parts that are included in every credit report.
Information
This section lists facts about you such as:
- Name
- Date of Birth
- Employer
- Social Security Number
- Past Employers
- Previous Addresses
- Names Previously Used
Your Credit History
- The age of your loans (how long you have had a particular credit card or account)
- Late payments (payments that have been outstanding for longer than 30 days)
- Delinquencies (charge offs, accounts settled for less than the full amount)
- Inquiries (requests by lenders to view your credit report)
- New Credit (recently opened or acquired accounts)
The credit reporting bureaus use an algorithm, or formula to determine your overall score. The breakdown is as follows:
Payment history 35%
This details how many on time and late payments you have made since your account was opened. Generally speaking, the longer you have had an account with on-time payments, the higher your score will be. Newer accounts with a positive payment history typically have less of an impact than older ones.
Amounts Owed 30%
This is the total amount of all of your combined debt. The lower the percentage of your debt to your income, the better. Although your credit report generally does not reflect your income, lenders who are reviewing your entire financial picture will look at the amount of debt you owe versus the income you are receiving. A healthy percentage of debt is no more than 28% of your total income.
Length of credit history 15%
The older the better. This can also work in reverse, however. If you have had credit accounts for 20 years and they’ve always been delinquent, that also weighs heavily on your score. Financial experts suggest keeping old accounts open, even if they are not in use as the age of the account alone can help to boost your score.
New credit 10%
This reflects any new accounts that you have opened recently. Typically, opening a bunch of new credit accounts at the same time can adversely affect your score. Be careful when opening new accounts. Spread out your new accounts over time to avoid negatively affecting your score.
Types of new credit 10%
Unsecured loans, those that are not backed by collateral, are usually more valuable to your credit score than secured loans. Unsecured loans include personal loans, student loans and other loans that are granted based solely on your agreement to pay.
Secured loans also count when figuring in your credit score, but carry less weight. These are loans that are backed by physical property that can be repossessed if you do not follow through with your agreement to pay. These include car loans, mortgages and credit cards, for example. The most common type of secured loan is for real property. Real property can include residential homes, commercial property, vacant land or other commercial real estate.
What is a good credit score?
After the financial collapse of 2007, many lenders clamped down on their lending requirements, making it harder for consumers to obtain loans. This drastically changed the definition of a “good” credit score. Whereas in the past a 600 credit score was enough to obtain some of the best rates on loans, borrowers today need scores in the higher 600s and low 700s just to qualify for the best rates. The lowest mortgage rates are usually reserved for those with scores in the 750 and higher range.
How do I improve my score?
The first thing you need to do to improve your credit score is to take a hard, objective look at your finances. Analyze how much money you are receiving in income versus how much you are spending. Make a plan to tackle your credit and set a date to reach the desired score.
Many people wonder how credit reporting works and how they can raise their credit score. By knowing how credit scores are calculated and taking steps to repair damaged credit, you will be well on your way to enjoying a healthy credit file.
