What’s your credit score? That bad, huh? Oh, you don’t even know. Well that’s okay. I’m going to walk you through some credit report basics so that you aren’t totally taken by surprise the next time you apply for credit or try to open an account somewhere. So here it goes. And a little warning — this might get long and you might wanna grab a piece of paper and a pen. Or at least bookmark this page.
A credit score is considered, by most financial institutions, the biggest indicator of creditworthiness. It is also considered the biggest indicator of the type of person that you are. I know, I know, that’s totally unfair. It really is. I agree. However, it doesn’t change the fact that financial institutions all over the country are going to judge you based on that number. But it’s really more than the number. Lots of factors in your credit report go into decisioning on the part of a financial institution. What factors, you might ask? Here are a few:
- Credit Score
- Number of Accounts
- Length of Credit History
- Length of Accounts Since Opening
- Payment History
- Amount of Debt Relative to Income
- Recent Credit Inquiries
I know. That seems like a lot. That’s because it is a lot. Financial institutions dig deep in order to mitigate risk when extending credit or opening accounts. When a financial institution pulls credit on you, they can do it in one of two ways. A “hard pull” of a credit report is the type of pull that is done when you are applying for a loan, a credit card, or any other extension of credit. These show up in the Recent Credit Inquiries section of your credit report. A “soft pull” is the type of pull that is performed when you are simply trying to open a banking account. And before we go any further I would like to clear something up. Here in the 21st Century, in 2017, financial institutions DO PULL CREDIT before allowing you to open a regular deposit or savings account. This gives them insight into whether or not you have charge-offs or collections from other financial institutions (and yes when you charged off that checking account 10 years ago over a 25.00 fee that you didn’t think was fair, that bank did report that to your credit and it does show as a charged off account). This lets them know if you are risky to do business with or if you keep all of your accounts in good standing. So a “soft pull” of your credit, although not as detrimental to your credit score as a “hard pull”, is still very telling.
So I’d like to break down each area that a financial institution or lender may be looking at on your credit report in order to judge whether or not they want to do business with you. This will give you some insight into what you need to take care of and what to avoid in the future.
Your credit score is basically a number that is assigned to sum up all of the things in your credit report. It’s the quickest way to determine if you have a good credit picture or a not so good credit picture. Most lenders aren’t looking strictly at the score, however, which can be a good thing because if you don’t have very much credit history, then your score will be naturally lower and it may have nothing to do with negative history whatsoever.
Number of Accounts
The number of accounts that you have open paints a picture of all of the things that you have to spend your income paying each month. It helps, along with your income, to determine if you could feasibly make another payment each month.
Length of Credit History
The length of your credit history, or the time that you have had trade lines reporting to your credit, can help a lender determine if you have had good payment history over a long or short period of time. This gives them some indication of the level of risk associated with lending to you.
Length of Accounts Since Opening
This one relates directly to Length of Credit History. Financial institutions might be more hesitant to extend credit to you if you have taken out multiple loans in say the last 4 months. This is because you might not have a good grasp on just how these payments will impact your income because you’ve not had time to experience it yet.
This one is pretty self explanatory. A lender won’t feel comfortable lending to you if you have late payments or are behind in other loans that appear in your credit report. They assume that if you aren’t able to pay those other lenders then you won’t be able to pay them, either. This can get tricky if you initially had a lower income and charged off or got behind on loans and now that your income has gone up you have every intention of paying this new lender on time and eventually paying them off. Unfortunately most lenders will expect you to pay off the derogatory records in your credit report before they will extend you credit. The same can be true for deposit accounts. If you have charged of an account at a different financial institution, don’t be surprised if your new bank won’t open an account for you until you clear up that charged off account.
Amount of Debt Relative to Income
By now you’re probably starting to understand why lenders and financial institutions care about your credit report. Their goal is to mitigate risk and not lose any money. They want to know that you have a steady flow of income and that you make enough money to make your payments each month and to eventually pay them off. If you only make 1400.00 per month and you want to take out a car loan that will have a 600.00 per month payment, you will need to not have very many other monthly payments or your debt to income ratio will be too high to make you a “safe bet” for a lender. The lender assumes that you will be responsible for normal utilities each month as well as full coverage insurance on that new car. And I should mention that you will have to carry full coverage insurance on any financed automobile because the bank wants you to protect their investment.
We’ve talked about charged off accounts. These items are referred to, in the banking world, as Collections or Derogatory Records. Another type of collection is the Derogatory Public Record. These are things like bankruptcy or tax liens that have been placed on your credit report. If you have a charged off loan or checking or savings account, it will report to your credit as a collection and will continue to do so forever until it is paid in full. In order to get a loan or an account at a new institution, you will need to pay these collections off. If you don’t, the new bank or credit union may not extend credit to you because they are worried that they might lose money.
This one may come as a bit of a surprise. Depending on the type of credit that you are applying for, financial institutions might be interested in knowing how long you have lived in all of the places that you’ve lived. This can tell them if you’re somebody who moves around a lot and will be hard to locate if you should default on your loan. They may also need this information in order for them to be in compliance with federal regulations such as the Bank Secrecy Act. Established after 9/11, this federal legislation forces financial institutions to positively identify potential customers so that they can be monitored for potential money laundering or other activity that could potentially fund terrorism. That’s the secondary reason that your credit is pulled. To verify your identity.
We’ve already established that employment is of high interest to potential lenders. They need to know that you have a steady income in order to be able to pay them back. Your credit report will include current and previous employment history, depending on how long you’ve been with your most recent employer. They may also require you to provide pay stubs or additional information so that they can verify your wages in order to calculate your debt to income ratio.
Recent Credit Inquiries
If you’ve been shopping around for a loan and you keep getting denied, all of those inquiries are probably showing on your credit report. Lenders want to know if you’re vigorously trying to get a loan and they will become suspicious if you have lots of inquiries in a short period of time. It shows them that you are in a hurry to get the money and that you need it fast, which can be a red flag. So if you are rate shopping, don’t fill out an application each time. Ask the lender, instead, for a range of rates that you might qualify for and once you’ve seen who offers the most competitive starting rate, apply there.
Okay so now we’ve covered everything that your credit report will tell about you and your past. It may seem overwhelming but I assure you it’s a lot simpler than you think. Whether you have a great credit score or a really scary one, there are steps that you can take to make it better. If you’re wondering where to start, I suggest getting a free credit report from a website like Annual Credit Report.com. There are even apps that you can download like CreditKarma. They’re super simple and easy to use and will give you some insight into what you’re working with. If you have collections or derogatory items reporting to your credit, start working toward paying them off. This may take a while, but those items aren’t going anywhere. You’ve got nothing but time. So be patient and keep in mind that even after you pay something off, it may take several months to fall off of your report. It’s a good idea to get a certified letter from any lender that you have collections with once you pay them off. That way if they don’t take the collection off of your report, you can dispute it with the credit bureaus. And if you notice something that doesn’t look like it belongs to you reporting to your credit, you can always reach out to the credit bureaus for assistance. As a victim of identity theft, I have worked closely with Equifax and it was very simple and they were extremely helpful and patient.
If you’re wondering, credit reports generally combine all of your information from the 3 major credit reporting agencies. Some institutions, depending on geographic location, use only one agency. If you need to find contact them to dispute something here are links to their websites:
The number can be scary and I get that. But if you understand what’s behind it, you have a better understanding of what you need to do to make your number whatever you want it to be. If you have any questions, feel free to ask. I’ll help you as much as I can! Let me know what struggles you’ve had that are negatively impacting your credit and what steps you’re taking to make them disappear! And if you found this post useful, share it!