What is Credit?
Credit is borrowed money that you can use to purchase goods and services with the intention to pay the amount back to your lender within a given time period and for an agreed upon cost. The cost of borrowing credit is known as interest. When applying for any type of credit, whether that be for a credit card, a personal loan, or a home, the creditor (typically a bank or credit union) requests a copy of your credit report from one or more of the three major credit bureaus. The creditor will then examine your credit report, credit score, or other information you provide to determine your credit worthiness and interest rate. If approved, your new loan and payment history will be included in your credit report going forward. Once a month, creditors send updates to each of the credit bureaus, which include information about how customers use and pay their accounts. These updates, are the basis for individual credit scores which determines the likelihood of getting approved for a loan, as well as the cost of borrowing.
What is on Your Credit Report?
Your credit report reveals many aspects of your borrowing activities, including a credit score. Along with other pieces of information, the value of FICO® Scores allows lenders to fairly and consistently consider all information when making a decision. A credit report lists what types of credit you use, the length of time your accounts have been open, and whether or not you’ve paid your bills on time. The report essentially tells lenders how much credit you have used and whether you’re seeking new sources of credit. A credit report will also include personal information like where you live, and whether you’ve a lien or filed for bankruptcy.
Who Can View Your Credit Report?
Credit is used for more than determining if you are approved for a loan and how much it will cost. Individuals seeking a new job, applying for an apartment, and purchasing insurance for their car or home are subject to credit reviews in order to determine their qualification for these opportunities. In the case of insurance, credit quality will determine the cost of coverage. Typically, the higher your credit score, as well as the fewer blemishes (i.e. missed payments, bankruptcy, etc.) reported on your report, the lower the cost will be for insurance and interest charges for loans.
What is the Credit Score?
Traditional credit scores, which are based on data analytics originally created by Fair Isaac Corporation (FICO), range from 300-850 points. FICO scores are the most commonly used credit scores by lenders. Each of the three major credit bureaus (Equifax, Experian, and TransUnion) use your credit history to determine a score, which is then used by lenders, in part, to make a decision on your loan application.
Credit scores influence the amount of credit available to individuals, as well as the terms (interest rate, etc.) that lenders may offer you. Lenders want to know what risk they’d take by loaning money. When lenders order a credit report, they can also purchase a credit score that’s valued accordingly to the information in the report. A credit score helps lenders evaluate a credit report because it is a number by the value summarizing the credit risk, based on a snapshot of a credit report at a particular point in time. In general, the higher your credit score, the lower the cost of borrowing.
How Can You Establish and Build Your Credit Score?
The five components of an individual’s credit score include:
- Payment History – Your payment history on loans represents 35% of your total credit score. When you take out a loan, the most important thing you can do is to make all payments on time. On-time payments help to build your credit score and demonstrates to potential lenders your commitment to meeting financial obligations.
- Credit Utilization – How much credit you have available to use vs. how much you use is an important piece to your credit profile. Credit utilization determines 30% of your overall credit score. This aspect of your credit report is determined by your use of open lines of revolving credit, like credit cards or equity loans. While these loans exist to help you when you need them, it is important to remember that maxing out credit cards (i.e. using all available credit) can lower your credit score. The lower your credit utilization, the higher your score has the potential to go. It is recommended to use no more than 30% of your credit limit. For example, if you have a $1,000 limit credit card, you should try to have no more than a $300 balance at any given time.
- Length of Credit History – The length of time you have credit in your name represents 15% of your credit score. The length of time you have a credit card account, student loan, or even home loan helps to determine your credit score. Lenders want to see that you have the discipline to pay on debt over time. Your length of credit history can be created by establishing credit and maintaining a positive payment history. The longer the length of healthy credit the better the impact it has on your credit score.
- New Credit – Everyone needs credit from time to time. It is important to know that how often you apply for credit can determine 10% of your overall score. When applying for a credit card, car loan, home loan, and more, the credit bureaus track your applications and adjust your score each time a new loan is sought. A good rule of thumb is to apply for credit only when you need it. (All credit inquiries stay on your credit report for two years.) The more you apply for credit, especially within a short amount of time, the more you risk lowering your score.
- Credit Mix – The two main types of credit are installment loans (i.e. car, home, etc.) and revolving lines of credit (i.e. credit card). Installment loans have a set amount of payments for a predetermined amount over the life of the loan. For example, a car loan might be issued for 60 months and cost $400 each month. Revolving lines of credit, most often associated with credit cards, offer borrowers an amount of credit that they can access as needed and pay back over a set amount of time until the balance is $0. For consumers, 10% of their credit score is determined by credit mix. This simply means that the credit bureaus look for consumers to utilize both installment loans and revolving lines of credit responsibly.
How Can You Use Credit Wisely?
There are a number of ways for you to maximize your opportunity to build a strong credit score and get the loans you need to live a quality life. Some of these strategies include the following:
- Charge small amounts on revolving lines of credit and pay on time
- Don’t max out credit cards
- Don’t open up a lot of new accounts (i.e. credit cards, personal loans, etc.) at one time
- Only paying the minimum amount on a loan
- Late or over-the-limit fees
- Cash advances
Where Can I Get a Copy of My Credit Report?
The only way you can know the status of your credit is to see your credit report from one or more of the credit bureaus. While there are many services that advertise on TV, the internet, and radio about how you can access your credit report, they often charge for their services. You DO NOT have to pay to access your credit report. The following are a few FREE ways to access your credit information:
- annualcreditreport.com – The federal government requires that each of the three major credit bureaus provide consumers with one free copy of their credit report every 12 months. By visiting www.annualcreditreport.com, you can access secure websites from Equifax, Experian, and TransUnion that will allow you to view, save, and print your report. This credit report will not have your score included. However, what is on the report is important. When you access your credit report you will be able to review it for any errors, which can range from your name being misspelled to there being inaccurate or fraudulent credit files associated with your identity.
To maximize your access to each of these reports, one strategy you might use is to request a report from a different bureau every four months. For example, you might do the following:
- January 2019 – Request credit report from Equifax
- May 2019 – Request credit report from Experian
- September 2019 – Request credit report from TransUnion
- January 2020 – Request credit report from Equifax
Because you have to wait 12 months after each time you pull a credit report, by pulling one report from a single bureau on a rotating schedule, you can maximize the number of times that you are able to review your credit information. This strategy may be one way to help you monitor for inaccurate personal information and/or credit information.
- Prosperity Connection – Prosperity Connection, a St. Louis-based nonprofit, has a team of financial coaches who provide free and confidential financial coaching services. Coaches have the ability to pull a free copy of your credit report, with a score included, to help you establish and achieve your financial goals. If you are interested in meeting with a coach to discuss your personal financial situation, as well as potentially get a copy of your credit report and score, please visit prosperityconnection.org to learn more about the organization and its coaches. Appointments may be made via email or by visiting their website.
What if My Credit Report has Inaccurate Information?
It is not uncommon for a credit report to have errors. That is why it is critical for everyone to regularly review their credit to ensure that personal and financial information is correct. In the event that an error is found, you can do the following to correct the situation:
- Report errors to all three credit bureaus by either calling them directly using their dispute portal or by sending in a written letter explaining the incorrect reporting. Be sure to also include a copy of your government issued ID and any documents that support your claim. The agency must investigate your complaint within 30 days and notify you of the results
- Send any additional information that is needed to correct the error. The credit reporting agency will tell you exactly what you need to send. It is important to get into the habit of keeping all correspondence from creditors and bureaus for either seven years or until it is removed from your credit report.
- If the credit agency disputes the error and you still believe the information is inaccurate, contact the creditor directly. Once the dispute has been resolved, ask the creditor to send a correction to the credit reporting agency. The creditor must notify the major credit reporting agencies before the error can be corrected.
Prosperity Connection’s Financial Coaches recommend clients monitor their credit with services like Credit Karma or Credit Wise. It is only recommended to use these services monitoring the accounts on their credit report, not to track your credit score.