Planning to finance a home, rent an apartment or buy a car soon? You may want to spend a little time getting familiar with your personal credit score and how it might affect your plans. Recent studies have shown that most people don’t monitor their credit files on a regular basis and know little about the process. For example, a survey of 1,022 adult respondents, conducted by the Consumer Federation of America, found that more than 40% incorrectly believed factors such as age, marital status, race and employment type factored into their credit score. A better understanding of how credit scores work is an important part of any personal financial planning.
In the world of consumer reporting agencies (CRA) there are three primary players: Transunion, Experian and Equifax. These agencies, also referred to as credit bureaus, work with banks, lenders and retailers to compile your credit history, personal details and other information. They use this data to assess a credit score based on established mathematical formulas.
Myth: CRA’s Are Run by the Government
This is a common misconception. Credit reporting agencies are all for-profit companies and in business to make money. There are government rules and guidelines that regulate how they operate, but the federal government has no hand in daily management.
In short, you don’t have a single credit score. Rather, you may have a number of credit scores that apply to various situations. Each CRA works with a base of clients to gather information on your credit history but these clients don’t always work with all of the CRAs. For example, ACME Explosives Company may report to Transunion and Experian, but not to Equifax, whereas Roadrunner Safe Company may report to Equifax and Experian, but not Transunion. This means information included in your credit file may vary by CRA.
Information collected by each CRA is then used to calculate a credit score based on a variety of formulas. Formulas can be based on the familiar FICO (Fair Isaac Corporation) method or the newer VantageScore system. To further complicate the issue, there are variations on these formulas used to calculate a specialized credit score for auto loans, credit cards, mortgages and other types of credit. When applying for new credit, talk with your lender to get a better understanding of how they will establish your credit score.
Specific information related to your credit history has a level of importance or weight when calculating your credit score. Details such as your on-time payment history and credit utilization are given more weight than inquiries or length of credit history. As with every other factor related to calculating your credit score, these percentages can vary. In general, it’s good to have a balanced mix of credit types.
Negative credit history can have a major impact on your credit score. Late payments, collection accounts and multiple inquiries in a short time period can quickly lower your score. While you may not be able to avoid some issues, it’s important to review your reports on a regular basis and correct any inaccurate information. People are often surprised to find errant or inaccurate information in their credit reports. Disputes can often be submitted to the appropriate CRA via an online portal, helping speed up the process.
Guidelines for Student Loan Borrowers
Changes in how student loan debt is factored into creditworthiness decisions may open up more options for many people. This is especially applicable to potential home buyers, as it will affect how mortgage companies determine debt-to-income ratios.
Becoming familiar your personal credit reports and correcting issues quickly can help avoid delays or disappointment later on. Make a habit of monitoring your various credit reports on a regular basis. This type of monitoring can also alert you to possible identity theft or credit fraud appearing on your files.