Understanding Credit, Your Credit Reports and Your Credit Score

Jan 3, 2020 | Mortgage


Credit Basics

Credit is an essential part of today’s world. You should understand what credit is, what your credit report contains and how that information got there. You should know your credit score and what your score tells future lenders when you apply for a loan of any sort. When you do understand credit, you will be able to keep an eye on it. The better your credit, the less interest you will pay.

What is Credit?

Credit is how able you are to receive goods or services before you actually pay for them. You borrow money to buy an automobile with a car loan, or a home with a mortgage. You may borrow money to buy gas and groceries with your credit card or get a month’s electricity or cable TV before paying the bill. Credit, therefore, is a form of trust that sellers and service providers put in you on the understanding that you will pay the agreed amount when that amount is due.

What is a Credit Report?

A credit report is a history of what you have borrowed, who you borrowed from, and how well (or poorly) you paid the amounts that came due. Every time you get a new loan or pay off an existing one, it adds to your credit history and goes in the report. Credit reports are a running summary that lenders use to decide how big or small a risk they are taking if they were to arrange a new loan or to extend an existing one.

Who Produces Credit Reports?

Several companies produce credit reports, but there are three main bureaus which collect data, create a credit report, and make it available to you and to potential lenders. The three names are:

Other companies also produce credit reports, but these three are the main bureaus most potential lenders and creditors use.

What Goes in a Credit Report?

Each bureau collects slightly different data, but credit reports include:

  • Your personal data so lenders and creditors know it is you.
  • Details of any current and past credit accounts such as credit cards, store accounts, student loans, auto loans, home loans, etc.
  • Any records of bad debts, bankruptcies, consolidations, and charge-offs.
  • Any records of payments you made more than 30 days after they were due.

Details remain on your credit report for different amounts of time. Credit card details stay for as long as you keep the card. Bankruptcies may be reported for up to 10 years. Late payments or collections may stay for up to 7 years. Positive data also stays on your report for up to 10 years.

What is a Credit Score?

A credit score is a number you are given, based on your credit history. It is a quick and easy way for a lender to decide how good a risk you are. The longer your credit history, the better; the more positive records in your history, the better.

You will hear the term “FICO score” as well as credit score. FICO stands for Fair Isaac Corporation (founded by Bill Fair and Earl Isaac.) FICO is a data analytics company that creates and sells its reports. It uses the data in each report to create a “FICO Score.”

The three main credit bureaus select which data items they want to and create then their own score for each person. They all vary a little but, basically each bureau rates you from:

  • Poor: a score of less than 550 (short history and bad record, so high credit risk) to
  • Excellent: a score above 750 (long history and great record of using credit and paying debts on time, so very low credit risk.)

How is a Credit Score Calculated?

You need at least six months credit history to get an initial score. As long as you pay on time, or pay early, your initial core could be 500+.

The factors that go to make up a score are worth a certain percentage of the total score.

  • Payment History: 35%.
  • How much of your available credit you use: 30%.
  • The length of your credit history: 15%
  • Credit mix: 10% (credit cards, mortgage loan, auto loan, etc.)
  • Number of “hard” inquiries: 10% (a hard inquiry is one made by a company you applied to for a new line of credit.

How to Keep an Eye on Your Credit

Firstly, only apply for credit you need if you only have a short credit history. Secondly, you should get a free copy of your credit report every year from each of the three major bureaus listed above: Experian, Equifax TransUnion.

Go through the reports to make sure there are no mistakes or credit applications you did not make. You can “freeze” your credit record to protect yourself from fraud.You can “unfreeze” if you want to apply for new credit,

The Takeaway

Having good credit makes you attractive to lenders, and encourages them to offer lower interest rates to get your business. If you would like to discuss how you can protect your credit rating or discuss taking out a loan with us, please just click here.