UNDERSTANDING CREDIT
Creditworthiness represents a person’s ability to borrow. Credit reporting Organizations use the credit scoring system to determine whether a specific person is creditworthy and attempts to predict the likelihood a person will make payments for goods and services. Two types of credit information play a very big role in determining whether a person has access to credit.
1. The Credit Report
2. The Credit Score
Establishing credit can be difficult and it requires taking steps that help create a more favorable financial future. Many people may think that paying off charges every month and never borrowing money is the key to a better financial future but, an excellent credit history is using credit wisely and avoiding common misconceptions about credit itself. Pay your bills on time, review your credit report annually at annualcreditreport.com to determine if there are errors or any unpaid debts, and prove your ability to handle credit. Cy-Fair FCU also offers a financial wellness tool called SavvyMoney. Savvy Money gives your instant access to your credit score, credit report, personalized money-saving offers, and financial education tips. Simply log in from your computer or mobile app and click “Launch SavvyMoney” to get started. These are all steps a person can take to ensure their credit score stays strong and healthy.
Information that is stored on a Credit Report
Positive information is saved on the credit report for 10 years from the date the account is closed. Negative information is saved on the credit report for 7 years from the date of the first delinquency that leads to the final default, charge off, or foreclosure. Below is a list of items that are most frequently asked about.
1. Tax Liens, Financial Judgements, and Chapter 13 Bankruptcy is stored for 7 years.
2. Chapter 7 Bankruptcy is stored for 10 years.
3. Unpaid Tax liens are stored indefinitely.
4. Inquiries are stored for 2 years.
Obtaining a free copy of your credit report
The FCRA includes a “Fair Disclosure Rule” which requires each of the credit reporting agencies to provide consumers with a free copy of their credit report once every 12 months on request or if special circumstances arise. Equifax, Transunion, and Experian use a single point of contact for processing credit report requests.
Annual Credit Report Request Service
Po Box 105281
Atlanta, GA 30348
A consumer can also receive a free credit report if one of these three situations occurs.
1. A company reports an action that has an adverse impact on your credit.
2. You become unemployed (unemployed individuals can ask for a credit report if they plan to seek employment within 60 days).
3. Identity Theft.
Understanding your Credit Score
The credit score used by most lenders is the FICO score. The fico score is a number that can range from a low 300 to an 850 depending on the model used by the reporting organizations. This score reflects the individual’s ability to pay for services or repay loans. There is a lot of miscommunications about what is included in your score. Below is a list of information that is not included in the credit score.
1. An interest rate being charged on a credit card or other accounts.
2. Child or family support payments
3. Rental Agreements
Credit scores are calculated using these 5 key factors.
1. Payment history is 35% of the credit score. The payment history reflects if the member pays on time. Late payments will bring down the score significantly. This element of the score is weighted to give recent activity more consideration. These are approximately the credit weights broken down for each year.
40% is based on current – 12 months
30% Is based on 13-24 months
20% is based on 25-36 months
10% is based on 37+ months.
2. Capacity or better known as credit utilization is 30% of the credit score. Capacity refers to the amount of the available credit on existing revolving accounts. The key to good credit utilization is to keep the balance at less than 30% of the credit limit. Balances below 20% will improve your credit score further.
3. Age of accounts is 15% of the credit score. The longer you have the account the better. Closing an older account can lower an individual’s credit score by almost 150 points. It will reduce the average age of all open accounts and will impact your credit utilization because there is now less credit available.
4. Debt accumulated in the last 12-18 months is 10% of the score. This includes all new debt taken out within the last 18 months and takes into consideration balance transfers.
5. The mix of credit is 10% of the credit score. Different types of credit are given different values in each scoring model. For example, Mortgage debt has more weight than installment credit such as an auto loan which results in a higher value. Whereas revolving credit like credit cards are scored at a lesser value.
Actions that can undermine a healthy credit score
There are several actions that a person can do that will lower the credit score and cause you to be a higher credit risk.
1. Missing Payments. Missing a single payment on any obligation reported can drop the credit score 50-70 points. Missing payments more frequently will penalize you more severely than someone who does not.
2. Maxed out credit cards. Maxing out your credit cards can lower your score by as much as 100 points. Try keeping the balance between 20-30% of your credit limit.
3. Closing Credit Lines. When you close a credit line it will reduce your capacity. Positive credit will remain on your report indefinitely, however, closed accounts in good standing are usually removed from the credit report 10 years after closing. Open or closed, once that account is removed from the report all of that good history is gone.
4. Aggressively applying for credit. When you fill out a credit application you are giving that lender permission to pull your credit. When this is done it is called an inquiry. The inquiry will remain on your credit report for 24 months but will only impact your score for 6 months. The more inquiries you have the more it can hurt your score. However, consumers are not penalized for shopping for the best rates on Mortgages, Auto, and Student Loans. Any number of these types of inquiries will only count as 1 if it is within 14 days. This is not the case when applying for credit cards.
5. Opening multiple new credit lines and loans in a short time. New debt transferred debt and increasing credit lines can temporarily lower the score if done within 6-12 months. When combined with multiple inquiries the damage to the credit score is even greater.
6. Using only revolving debt. It’s important to have a good mix of installment and revolving debt. This shows the lender you can handle different kinds of debt.
Five simple steps to improving your credit score
Whether you have high-interest rates or are just getting outright declined when applying for credit you can follow these five simple rules to help restore your credit score.
1. Pay bills on time
2. Keep bills current and under the credit limit.
3. Maintain low balances on your credit cards. 30% or lower will improve your score quicker
4. Apply for new accounts only when necessary.
5. Verify your credit report for accuracy. Repairing the credit score can take time but given the high cost of bad credit its worthwhile.