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Facts About Credit Scores:
How to Read a Credit Report
It's easy once you understand the format of the report.
If you thought grades ended when you graduated from school, think again. As an adult, you still get graded on your use of credit, but instead of receiving an actual grade, you receive a credit score. Your credit report is easy to read once you understand its components.
Personal Information
Personal, identifying information is on your credit report. This includes all of the following information:
- Your legal name plus any previous names that you have used, including your maiden name, if applicable
- Social Security number
- Date of birth
- Current and previous addresses
- Current and previous phone numbers
- Current and previous employers
Credit history
Your credit history is essentially a biography of your use of credit. It reflects how much debt you have acquired and how well you have done paying it off. This is shown through the following information:
- Open and closed accounts
- Date accounts were opened
- Credit limits and loan amounts
- Outstanding balances
- Payments and payment patterns
- Whether any co-signers or joint account holders share any of your debts
- Inquiries (a third party requesting your credit score)
Public record
Your public record information is also included on your credit report. This includes items like:
- Overdue child support payments
- Tax liens
- Bankruptcies
Your grade
When a third party makes an inquiry into your credit report, it does not usually receive the entire report. Instead, the credit bureau, who has compiled the data for your credit report, summarizes the information with a three-digit number, referred to as your credit score. Typically, the higher the number, the better the score, but each third party decides its acceptable range of scores for itself. This credit score tells the third party how likely you are to repay the debt.
Know your score
It is a good idea to keep on eye on your credit report. You are legally entitled to one free look at your credit report per year, and it does not adversely affect your credit score. This gives you a chance to have any mistakes corrected so that your credit score remains high.
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Credit scores:What the numbers mean
How high or low is your credit score? You could be paying a price for not knowing.
Your credit score is a measure of your past ability to make payments on time and manage your credit. It’s designed to help lenders determine how likely you are to pay back your loan. The number is calculated using a formula created by Fair Isaac Corporation, which is why it’s also referred to as your FICO score. According to Fair Isaac, the median FICO credit score in the U.S. is about 720.
But what do these figures really mean? How do they affect the type of loan you qualify for? And what about other parts of your financial life? Here’s a rough guide to the numbers:
720 and above: You have excellent credit and will likely be eligible to receive a lender’s most favorable rates. In fact, you’re in a position to shop around and demand the best possible conditions. Lenders will often allow you to borrow more than 80 percent of the value of your home, and may not require private mortgage insurance. You will likely be able to get a home equity loan or line of credit with an interest rate equal to the prime rate, or even below it. You can also look for a credit card that will reward you with a low interest rate -- while many cards charge 18 percent, you should be able to obtain a rate under 10 percent.
675 to 719: Once your credit score dips below 720, you may no longer be approved for the lender’s best rate, but you should have little difficulty finding a good loan. On a 30-year fixed-rate mortgage, expect to pay up to half a percentage point more than someone in the top category. If your principal is $150,000, the difference between 6.5 and 7 percent works out to about $18,000 over the life of the loan.
620 to 674: With a below-average credit score, your options will be reduced, and you’ll pay a premium on your loan -- perhaps as much as 2 percent more than borrowers with excellent credit. You may need to provide more documentation than those with higher scores, including a formal appraisal of your home’s value. But if you make your payments regularly and work to improve your credit score, you should be able to refinance at a better rate, which can save you money over the life of the loan.
Below 620: A credit score under 620 puts you in the category of a “sub-prime” borrower. If you are approved for a mortgage with a credit score this low, you’ll likely pay about 3 percent more than someone with excellent credit. If you’re looking for a home equity loan or line of credit, expect to pay double-digit interest rates. Of course, once again, if you make regular payments on the loan and get control of other areas of your financial life, you should gradually be able to improve your score and qualify for a lower rate. (See Improving Your Credit Score)
Your credit score can also affect the rate you pay for car insurance. People with low credit scores are statistically more likely to make accident claims, and as a result, many insurance companies take this into account when they set your premiums.
Poor credit may even hamper your job search. While a company interviewing you is not permitted to access your score, they are allowed to request (with your written consent) a modified version of your credit report to see whether you have a history of meeting your financial responsibilities. Potential landlords may also access your credit report before you sign a lease.
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Credit Report: Inquiries may affect your score
Certain inquiries into your credit report affect your credit score
On a credit report, one of the five categories that affect your score is “Inquiries.” These are requests made by third parties to examine your credit history. A variety of parties have the legal ability to make inquiries into your credit report: lenders, potential employers, retailers, landlords, insurance companies. Sometimes this adversely affects your credit score, but sometimes it does not. It depends on whether the inquiry was a soft inquiry or a hard pull.
Soft inquiry
A soft inquiry, or soft pull, is a term used to refer to an inquiry to a credit report that does not adversely affect the credit score. Often, you are not even aware that there has been a soft pull on your credit report. For example, if you receive a credit card solicitation in the mail offering you a credit balance, the credit card company has most likely conducted a soft inquiry on your credit report to see if you qualify. When mortgage lenders pre-approve you for a loan, they use a soft pull initially. Potential employers use soft pulls as a part of background checks. Your current credit card companies run them just to check up on you, and banks use soft pulls to verify that you are who you say you are when opening an account. If you check your own credit report, which you can do for free once a year, this is also done with a soft pull. For most soft inquiries, you do not even know when they occur, and they do not affect your credit report.
Hard pull
A hard pull on your credit report is different. It does affect your credit score. Anytime that you are actually getting a loan, or opening a new line of credit, the lender conducts a hard pull on your credit report. This stays on the record. It also lowers your credit score by about 5 points for 6 months. For this reason, it is important to guard your credit report from too many hard pulls. If you get a store credit card just to save 10 percent on a single purchase, you have hurt your credit score for that 10 percent savings. That is probably not worth it. Some banks even use a hard pull if you are opening a savings account, so be sure to check your potential bank’s policy. And, with credit cards, the incentive that they offer for signing up may not be worth the hit to your credit score.
Try to avoid too many hard pulls into your credit report. This can help you keep your score high so that when you need to apply for a loan, you’ll have a better chance for a great interest rate.
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Six credit score myths
Don't be misled by rumors. Understand what truly affects your credit score so you can work to improve it.
When you apply for a mortgage, line of credit or even a department-store credit card, the lender will check your credit score. This figure, a measure of your past ability to make payments on time and manage your credit, will be somewhere between 300 and 850, with the average American coming in around 678, according to Experian’s 2005 National Score Index. If your score is too low (most lenders consider anything below 620 to be "sub prime," or higher risk) you may not get the loan you’re seeking or, if you do, it will likely carry a higher interest rate.
With so much riding on this number, it’s important to understand what factors affect it. Unfortunately, there’s a lot of misinformation floating around about credit scores. Here are six of the most common myths and the facts to set you straight.
MYTH #1: The major bureaus use different formulas for calculating credit scores.
The three major credit bureaus -- Equifax, TransUnion and Experian -- sell their services under different names, but they all use the same formula to arrive at their numbers. Your score may vary slightly between the bureaus, however, because each has different information in your file. For example, one bureau’s records may go back longer, or a previous lender may have shared its info with only one bureau and not the other two. Unless the scores are wildly at odds, many lenders will use the one in the middle when they consider your application.
MYTH #2: Closing old accounts will boost my credit score.
Having too many credit accounts can negatively affect your credit score, but canceling them may not improve it. In fact, it could do harm. To measure your ability to manage debt, credit bureaus look at the amount of credit you’re using compared with the total amount you have available. So closing unused accounts reduces your untapped credit and may make you appear overextended. Closing your oldest accounts is even worse because the longer a line of credit is open, the more history you’ve accumulated. If you do close an account, consider closing your newest one and transferring any balance to an older one.
MYTH #3: Shopping around for a mortgage or car loan will hurt my score.
When a lender makes an inquiry about your credit, your score has the potential to drop up to five points. For this reason, some borrowers are afraid that comparison-shopping for a mortgage or auto loan will result in multiple deductions. This isn’t the case. The score is set up to take into account that even though you are only looking for one loan, multiple lenders may request your credit report (i.e. make an "inquiry"). For that reason, all mortgage or auto inquiries made in the 30 days prior to when you choose your loan will not affect your score. To determine your score, the credit agencies also look back at any auto or mortgage inquiries that were made in the past two years (but are older than the 30 day window). If there are any within that 2-year window, all of the inquiries that fall into a normal "shopping period" are counted as just one inquiry when determining your score. The length of the "shopping period" varies depending on the version of the FICO scoring formula used by your lender and can be either 14 days (older versions of the scoring formula) or 45 days (newer versions of the scoring formula).
Here's an example: Say you are applying for a loan and are talking with four lenders. All four pull your credit report. If you choose a loan within 30 days of those first credit pulls, the inquiries will not affect your score. The score then looks at the past two years of your credit report. Say you applied for a car loan a year ago with three lenders. If your current lender is using the older version of the scoring report, all three inquiries will count as only one inquiry, as long as they occurred within 14 days of each other.
MYTH #4: Paying off my debts will instantly repair my credit score.
Your credit score is a measure of your past performance, not your current debt load. Paying off your credit cards and settling any outstanding loans will certainly help, but if you have a history of late or missed payments, it won’t undo the damage overnight. Improving your credit score takes time, so after paying down your debts, make an effort to consistently pay your bills on time.
MYTH #5: Companies can fix my credit score for a fee.
You may receive an offer from a company that claims it can fix your bad credit rating. The truth is if the credit bureaus have accurate information, there’s nothing you or anyone else can do to quickly improve your score if you haven’t managed your debts well in the past. (The only way to influence your score is to start managing your debt wisely.) And if there are errors in your file, you can contact the bureaus directly -- you don’t need to pay someone else to do it. The three major bureaus have instructions on how to do this on their Web sites.
MYTH #6: Requesting your own credit report will affect your score.
Credit bureaus do not penalize you for checking your own score, nor do they deduct points for inquiries from landlords or employers who may check your score with your permission. On the contrary, it’s a good idea to check your credit score with all three bureaus occasionally, especially if you plan to apply for a loan. This gives you an opportunity to correct any errors in your file before lenders make their inquiries.
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8 steps to great credit
Having a good credit score is more valuable than you might think. Here are eight simple ways to make sure you're getting the highest score you can.
Lenders view your credit score as a measure of your financial trustworthiness. They’re more likely to lend you money and charge you a lower rate of interest if your score is good. So, it’s in your best interest to try to build the best credit rating you can. While you can’t raise your score overnight, you can improve it if you follow these steps:
1. Establish a credit history.
In order to have the best credit rating possible, it’s important to establish a history of responsible borrowing. If you currently don’t have any credit history, you may want to consider applying for a gasoline company credit card. Not only are these usually easy to obtain, but gas cards can be a great way to charge regular small purchases each month without being tempted to overspend.
2. Pay your bills on time.
Late payments are often the single biggest factor in a low credit score. When you receive your credit card statements, utility bills and other payment notices, put them in a prominent place where you won’t forget about them. Or, better yet, to ensure they’re always paid on time, arrange to have them automatically paid each month via direct debit from your bank account. If you do this, however, take care you maintain a sufficient bank balance to cover them so you don’t end up getting hit with charges for having insufficient funds.
3. Review your credit reports.
You can request a free credit report from each of the three bureaus (Experian, Equifax and TransUnion) once a year. Review your files at all three bureaus, and if you find mistakes or missing information, contact the bureau to resolve the issue. Instructions for reporting errors are on each bureau’s Web site.
4. Reduce your debt.
Sure, it’s easier said than done, but try to lower your credit card balances and lines of credit a few months before applying for a mortgage or personal loan. One of the important factors included in your credit score is the difference between the current balances and the available limits on your accounts. Try to keep the balances under 30 percent of their allowable limits.
5. Make sure lenders report your credit limits.
Here’s a tip that few people know about: Some credit card issuers do not report your credit limit to the bureaus, so your account may appear to be maxed out even when it’s not. For example, if your card balance is $1,200 and your limit is $12,000, you’re at a very healthy 10 percent ratio, but if your limit is not reported, your score won’t reflect this. Correcting the problem -- by asking credit card companies to report your limit -- may improve your score considerably.
6. Confirm your good credit history has been reported.
When you check your credit report, you may find there’s no record of a loan you successfully paid off or a credit account that you’ve kept current. If so, ask the lender to report this positive history to the credit bureaus or send a letter to the bureaus yourself, along with copies of the statements showing you’ve paid on time.
7. Don’t apply for, or cancel, accounts you don’t need.
If your credit report shows you’ve applied for a lot of different kinds of credit in a short period of time, your credit score may drop, especially if you have a short credit history or few existing accounts. (However, multiple inquiries within 14 days for home and auto loans are counted only once.) That’s why it’s usually a bad idea to sign up for cards you’re not likely to use. If you have already opened a number of accounts, however, don’t rush to cancel them. Closing accounts, especially ones you’ve held for a long time, will reduce your available credit and may shorten your credit history, which can lead to a lower score.
8. Monitor your credit regularly.
While an annual credit check is often enough, if you’re actively trying to improve your credit it’s a good idea to track it more regularly. There are many companies that offer credit monitoring services.
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Improving your credit score
Understanding the factors that go into your credit report can help you improve a less-than-perfect score.
Credit scoring models are complex and often vary among creditors and for different types of credit. If one factor changes, your score may change, but improvement generally depends on how that factor relates to other factors considered by the model.
Only the creditor can explain what might improve your score under the particular model used to evaluate your credit application. Nevertheless, scoring models generally evaluate the following types of information in your credit report:
- Have you paid your bills on time? Payment history typically is a significant factor. It is likely that your score will be affected negatively if you have paid bills late, had an account referred to collections, or declared bankruptcy.
- What is your outstanding debt? Many scoring models evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, that may hurt your score.
- How long is your credit history? Generally, scoring models consider the length of your credit track record. An insufficient credit history may have an effect on your score, but that can be offset by other factors, such as timely payments and low balances.
- Have you applied for new credit recently? Many scoring models consider whether you have applied for credit recently by looking at inquiries on your credit report when you apply for credit. If you have applied for too many new accounts recently, that may negatively affect your score. However, not all inquiries are counted. Inquiries by creditors who are monitoring your account or looking at credit reports to make prescreened credit offers are not counted.
- How many and what types of credit accounts do you have? Although it is generally good to have established credit accounts, too many credit card accounts may have a negative effect on your score. In addition, many models consider the type of credit accounts you have. For example, under some scoring models, loans from finance companies may negatively affect your credit score.
Scoring models may be based on more than just information in your credit report. For example, the model may consider information from your credit application as well: your job or occupation, length of employment, or whether you own a home.
To improve your credit score under most models, concentrate on paying your bills on time, paying down outstanding balances, and not taking on new debt. It’s likely to take some time to improve your score significantly.
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How Long Does It Take To Improve My Credit Score?
There are no specific rules governing either how long it takes for your credit score to increase or how many points it can go up during any set period. Depending on how you handle debt -- from your mortgage payments to your credit card bills -- your score can actually change from month to month. Most people, however, won’t see their score go up more than about 30 points during any three-month period.
If you have a low score, you can work to improve it by paying all your bills on time and paying down the balance on your credit cards. That means paying not just the required minimum amount listed on your statement but gradually paying off the entire outstanding balance.
Keep in mind, though, that certain things may impact your credit record longer than others. For example, filing for bankruptcy will continue to tarnish your credit score for seven to 10 years. Defaulting on a loan will drag your score down for seven years from the date you made your last payment on that account.
And remember, while paying off your credit cards and loans is good for your score, closing your accounts altogether is not. A good credit history is one that includes one or two loan accounts that have been opened and used responsibly for a long time.
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