- Where Does Credit Report Information Come From?
- What Is a Credit Score and Why Should U Care?
It’s safe to say that without the invention of the microchip, you wouldn’t be concerned about that three-digit number known as your credit score. The mathematical calculations (algorithms) used to determine your credit score are so complex, that it would take a statistician several hours by hand to calculate your mysterious number. These calculations rely on enormous amounts of data that are stored for 10 years. Without that darn microchip, you might be able to dress or talk your way into a new home or car, instead of praying for a good score, which is based upon data that is literally updated monthly.
Basically, anytime you sneeze or cough, your credit file is updated. Data about you is being collected at any given time.
It begins when you first engage in a consumer-to-business financial transaction with a creditor and never stops until you have completely satisfied the terms of your agreement. It remains on your report for about seven more years.
Throughout the entire relationship, information gathered by the creditor is reported to the credit reporting agency (CRA) and can include anything from your payment history to your home address and phone number. And if you thought you’re protected because you avoid giving out your social security number (or at least a correct one), you’re wrong! A creditor can easily report information using just your name and address. This is how many collection accounts, public records and bad checks appear on your credit report.
Here is a sample list of who may be reporting information about you.
Common Business Types That Report Information to the CRAs:
Credit Card Companies
In addition to major credit cards, gasoline companies and department stores report your credit history.
Banks and Lenders
Anything offered by a bank or lender –including auto loans, mortgages and lines of credit
Both federally guaranteed and private student loan payment histories and delinquencies.
These are private organizations reporting on defaulted accounts assigned to them or purchased by them – including loans, credit cards, medical bills and utilities.
Local, State and Federal Governments
These include tax liens, child support and bankruptcy filings.
Information on your application for insurance is often reported, as well as any deficiency balance you may owe to your insurer for overpayment of proceeds or underpayments of premiums, as well as obligations to third-party insurance companies in the case of damage you caused while under- or non-insured.
While most landlords may not report your many years of good payment history, rest assured they will likely report a collection or judgment for uncollected rent or damage to the property.
Recently, some utility services started reporting payment histories although the majority of remarks seen on your credit file will be for an unpaid bill that lapsed several months ago.
As you’ll learn, there is a legal distinction between a creditor and a collector. A creditor, as defined by the Fair Credit Reporting Act is: Any person who offers or extends credit creating a debt or to whom a debt is owed. This excludes collection agencies which are defined as “parties who receive an assignment or transfer of debt in a default stage solely for the purpose of facilitating collection of such debt for another.”
In the spirit of Orwell’s 1984 and his conspiracy theories, a lot of it is actually true after all. Anything you do – even with the omission of your social security number – could be reported to the CRAs. The latest craze is when you are asked to verify information to establish a part of your identity you thought was irrelevant and surely private. Try sending money using Western Union over the phone. They’ll ask you to reveal all sorts of facts, such as a parent’s date of birth. Or try opening an account with a cable company – if your service is based on pay-as-you-go, why do they claim they need your social security number (so they now have your address, social security number and telephone number all on one nice screen for thousands of their company reps to view at any time).
A credit score is the result of a complex and highly proprietary algorithm (mathematical equations) used to calculate your financial risk level – and ranges from 350 to 850.
Many of those convoluted arithmetic problems you weren’t able to grasp in junior high are being used to determine if you are worth doing business with in the eyes of a creditor. The most common of credit scores is the FICO score, which is named after the company that created it, the Fair Isaac Company.
The basic premise behind the FICO score is to predict your likely rate of delinquency over the next two years. In other words, what is the chance of you falling behind? It’s this risk assessment that ultimately sets the terms the creditor will extend to you, such as your interest rate and down payment. So what do the bulk of these fancy mathematical equations factor in when determining your credit score…?
This means exactly what it says. Late payments cause the worst damage to your credit report. This also includes collection accounts (a collection account is a past due account that is assigned or sold to a collection agency for further collection attempts) and charged-off accounts (a charged-off account is also a past due account, however, it is written off as a loss on a creditor’s tax return on the assumption that the account will remain unpaid). Conversely, timely payments, particularly within the most recent 12 months, will help improve your credit score – especially if you continue to remain on time.
The outstanding amounts you owe on your revolving accounts are the next biggest factor affecting your score (e.g., credit cards, gasoline cards, and department store cards). The FICO model equates the fact that if you don’t pay your balances in full each month you have a poor ability to manage money.
- If all things were constant in your credit file and the only information to vary was a single credit card balance that kept increasing, your score would likewise decrease as the amount of available credit diminishes
Let’s say you have some money left over at the end of the month and you want to put some extra toward your bills. Instead of spreading a little over every creditor, consider putting the bulk of your spare funds toward paying off the smaller balances first – with the goal of zeroing them out as soon as possible. This will begin to improve your score considerably because even one dollar remaining on your balance will indicate a balance not paid in full. Then, eventually get around to paying off the next smallest balance, and so on, until they are all paid off. This might go against the grain of the mathematical notion to take care of your accounts with the higher interest rates first, but this zero-out method is actually better for your bottom line score!
- FYI: Installment balances (e.g., auto loans, boat loans, personal loans) also have an impact on your credit score, but not nearly as great as the proportion of revolving balances to their credit limits. For example, a credit card with a $10,000 limit and $8,000 balance has more of a negative impact than a car loan that started at $10,000 and has since been reduced to $8,000.
- The longer you have been a customer with a particular creditor, the better. It’s understandable – newer accounts have not stood the test of time, and so the computer perceives you as a better risk the longer your accounts have been open.
- Believe it or not, new accounts and new inquiries resulting from applications for credit actually reduce your score. New accounts will have a negative impact on your score for about six months and you may experience as much as a 5-point drop for every inquiry you initiate when you apply for credit.
- Types of Credit (10%) Surprisingly, the types of accounts you have affect your score. If you have too many revolving accounts, your score will be impacted to a greater extent than having just as many secured loans. The FICO formula is top secret, but rumor has it that mortgages are given preference over finance companies and revolving accounts that are seen as more tenacious – depending on how many you have and how well you’ve maintained them.
Now, these were just the main factors that make up your score. But what does the score mean? The FICO score ranges from 350 to 850 (the higher, the better). This score is used to determine the likelihood of you fulfilling your commitment on a new or existing credit obligation over the next two years. You are compared historically to other consumers whose score ranged within a few points of your own.
To better explain, a chart below depicts the rate of delinquency for various score ranges broken down in 50-point increments. As you’ll see, if your credit score is 599 or below, FICO says there is a greater than 50% chance you will fall behind on an existing or new obligation over the next two years (or perhaps even file for bankruptcy). This does not guarantee you will default; it just means there’s a greater chance that you won’t pay your future bills on time.
The Rate Of Future Delinquency By FICO Over Next Two Years
So now you know the factors that make up the elusive credit score. Just remember, the most important part is the current status of your accounts. So if you are behind with accounts that are not defaulted (usually no more than four months past due), contact the creditor to find out if you can rehabilitate them and start bringing them current. If they are already charged off or in collections, you may want to consider another plan of action, such as negotiation. And, for goodness sake, don’t worry about a “settled for less” indication showing up on your credit report if you were already past due with your accounts and your credit report score is already affected. Once you pay off any negative account and you start paying your other original creditors on time, your score will keep climbing each month that goes by.