Chapter 3: Credit Scores – What’s the BFD?
Credit History & Reports
Now that we know everything there is to know about the history of credit scores, let’s step back and look at this topic from a bird’s eye view.
We know the players: borrowers, lenders, credit reporting agencies, and credit scoring companies.
We know some facts:
- credit scores are important (though we still don’t know exactly why or how – just that they are);
- we know that lenders look at credit scores that are calculated especially for their industry-specific concerns;
- and, finally, we know that consumers are paying a ton of money and are willingly signing away their privacy to buy educational credit scores.
It’s time to look at how the interplay of the moving parts — data, scores, agencies, scoring companies, lenders — creates a never-ending, intricate, complex, and secretive feedback loop.
Your behavior creates data which gets reported to credit agencies who sell the data to scoring companies who sell scores to lenders who lend you money which leads to new behavior which results in new data which is constantly being reported to the credit agencies…. And on and on and on.
I don’t know about you but my head is spinning.
We may as well start with some basic terminology.
Credit History – the collected body of data known about your financial life. This information originates from your bank(s), credit card companies, and any other lenders you’ve dealt with in the past.
Credit Agency/Credit Reporting Agency – the organizations that collect data about your credit use. These agencies generate and distribute credit reports. The big three credit reporting agencies in the U.S. are Equifax, Experian, and TransUnion.
Credit Report – the document, physical or electronic, containing your credit history.
Credit Score Providers – the companies that turn your reported credit history data into a number. FICO® is the best-known provider but by no means the only one.
Credit Score – a number assigned to you by a credit score provider based on your credit history. The number is meant to serve as a quick and easy indicator of the relative risk a lender might be taking if they lend you money.
Credit scores generally range from 300 – 850 though some scales go up to 900. The higher the credit score, the lower the estimated risk; the lower the score, the higher the estimated risk.
Bad Credit – a very generic term indicating a low credit score based on a troubled credit history. Having “bad” credit means you are considered a risky credit bet for lenders. This term is generally interchangeable with “poor.”
Good Credit – an even more generic term indicating a score that is not “bad” or “poor.”
There is no shortage of adjectives used to classify sub-ranges on the credit score scale: “very bad,” “fair,” “acceptable,” “excellent,” and “average” to name a few.
Credit Invisible – the condition in which a person has no credit history. If you have no credit history, you cannot be given a credit score.
Your Credit History is all of the data related to your use of credit as reported by the various creditors and lenders you’ve ever dealt with. If you recall, back in Section 2.1 – Timing, one of the dates related to credit cards is the Reporting Date — the date your credit card company reports on your credit behavior.
Each one of your creditors sends a report to each of the three credit agencies every month detailing your behavior as it relates to every active loan or line of credit you have — whether it’s a car loan, a credit card, a mortgage, student loans, etc. I specified that each creditor reports on every active account because it’s quite possible for you to have multiple accounts with the same lender. For example, I have a car loan and two credit cards with Chase. So every month, Chase sends three reports to each of the three credit agencies about my credit behavior.
And when I said that your credit history is all of the data related to your use of credit, I meant it! My credit history dates all the way back to 1983 when I applied for and opened my very first credit card. As a matter of fact, my report states that I opened the account on November 1, 1983. I was 19. [I added that tidbit; my report doesn’t actually state my age next to that credit card though the report does include my date of birth. I’m serious, these folks know everything about you.]
At this point you’re dying to know just what type of data we’re talking about, right? What exactly is included in those reports your creditor sends? It’s pretty much the raw data you might expect a creditor to have: how much you spent (if it’s a credit card), your outstanding balance (total amount owed — applies to both credit cards and fixed loans like cars and mortgages), whether you paid on time, how much you paid, etc.
As I said, each creditor is sending in raw data on each account held by each account holder. It’s the credit reporting agencies’ job to collate all that raw data into something meaningful. And that’s where the credit reporting agencies come in.
As I wrote earlier, there are three major credit reporting agencies: Equifax, Experian, and TransUnion. Each of these agencies gathers all of the monthly data submitted regarding your behavior on each one of your accounts, then they collate that data and distribute it to credit scoring companies in the form of Credit Reports.
Your report is organized by lender/creditor. Each section outlines who the creditor is, the type of account, the account opening date, whether the account is still active, the terms of the account, and whether you’re “in good standing” (are your payments up to date).
Hey, you, in the back, here’s fair warning: important information ahead!
I’m sorry about bursting your bubble about the whole Credit Score thing. If you went to sleep after you learned that your educational credit score is really little more than party favor, but I’m about to make it up to you.
While your score is just costume jewelry, your credit report is the real deal. If you want access to something relevant to your credit score that you can see and hold and it actually means something, that’s your Credit Report. And not only do I approve of you seeking out and checking your Credit Report, I strongly encourage it.
And the good news is — all three credit bureaus are required, by federal law, to provide you (upon request) with a free credit report once every 12 months.
To get a copy of your Credit Report from any one of these agencies, the place to start is AnnualCreditReport.com. Don’t be fooled by other companies with similar names and URLs. This is the only government-approved site for starting your request for your Credit Reports.
Adulting Tip #1: Pull a Credit Report three times per year. Seriously. Set up reminders in my calendar and request a history report from one of the agencies every 4 months.
To make it easy to remember, I start in January and work through the agencies alphabetically: Equifax in January; Experian in May, and TransUnion in September — but you can go in any order you wish and in any months that work for your schedule.
The reason for requesting one report every four months is that it allows you to keep a closer eye on things. Pulling all three reports in January means you would had to wait a full year to check again. By spacing your requests every 4 months, the theory is that you can fix any issues that arise before they can spread and cause permanent damage to your credit.
Spacing out your reports also also gives your some flexibility. If you did find an error or an account you don’t recognize, you could pull a second report from a different agency to see if they have the same information. If just one agency has funky data, it’s likely an error within the agency and you can contact them to get the errors fixed. But, if two or even all three agencies are reporting the same problem data, it’s likely to be a real-life, active fraud situation that requires immediate attention.
Errors on credit reports can be a huge, hairy mess and can be notoriously difficult to fix but checking your credit reports on a regular basis, at least you’ll find the issue. Errors and fraudulent use are nightmares I wouldn’t wish on anyone but the horrors of unchecked fraudulent use over several years is a nightmare of a completely different caliber. That’s a problem I would wish only on my worst enemy (if I had one). Identity theft and credit fraud are problems I hope you never have to deal with.
Bad Credit vs. “Credit Invisible”
Having “bad” credit refers to having information in your credit history and reported on your credit report that is unfavorable. You may well have data that’s not doing anything to help your score but that’s not the issue here. “Bad” almost always refers to a history of missed or late payments, loan defaults, bills that went to collections, and bankruptcy.
My experience is that people with “bad” credit usually know that their credit is bad and they know why.
Having bad credit makes you a credit risk in the eyes of creditors. You may have trouble securing loans and if you can get them, you’ll pay the highest possible interest rates.
The good news is that bad credit can be repaired. The bad news is that repairing it can take a long time. And the reality is that people with bad credit are usually not in that situation due solely to irresponsible behavior. Sometimes a person’s financial circumstances are so challenging that bad credit was inevitable and improving their credit will take a miracle.
Aside from “bad” credit, there’s another credit category that a person can find themselves in that results in high interest rates and reluctant loan approvals: those people are referred to as credit “invisible.”
To be credit invisible means to not have any credit history at all. There’s no history so there’s no report and, if there’s no report, there’s no score. This is the position we all start in. Until you open that first credit card account or take out that first loan, everyone is credit invisible.
What too many people don’t realize until it’s too late is that being credit invisible carries many of the same penalties as having bad credit. What I mean by “too late” is that instead of having the luxury of time to build a strong, positive credit history and a good score long before it’s time to ask for an important loan, you find yourself with no option but to accept unfavorable terms or a high interest rate.
Examples could be that you desperately need a car loan but you end up paying a 10% interest rate instead of 3%. Or you and your new spouse want to buy your first house together but your credit score makes you look too risky to mortgage brokers.
While the bad news is that being credit invisible can have the same effect as having “bad” credit, the good news is that become visible and building good credit is faster and easier than fixing bad credit.
Does It Really Matter?
Ummm, ….. yes!!!!
It really does matter. It matters a lot.
It’s important to understand that being credit invisible or having bad credit won’t just only keep you from qualifying for a mortgage or leave you paying a higher interest rate on your credit card. For better or worse, credit scores are used by people and industries to measure qualities way outside the realm of whether or not you’ll pay back a loan on time. Employers now routinely check the credit histories of job applicants. Landlords and rental agencies check the credit of prospective renters. And, depending on your age and social circle, your credit score could have a significant impact on your dating prospects.
Your credit score is a quantification of your credit history and a best-guess of your creditworthiness. While educational scores are worthless baubles, the score lenders access may prove to be one of your most valuable assets. It would be foolish to dismiss the cumulative impact of poor credit or no credit over a lifetime. Take the time to build a solid credit history — and put in the effort to monitor it. The lifetime benefit of a good credit score is incalculable.
next >> Section 3.3: Credit Scores