Credit Scores: A Complete Tutorial
The credit score, also known as a risk score, is a number summarizing the information contained in credit reports or other sources of information that measure the creditworthiness of individuals and businesses and allows an easy way to classify credit applicants based on their probable risk of default. A low credit score may mean that a borrower will pay hundreds of thousands of dollars more for credit over a lifetime, and may be the cause of a denial of credit. This article will show how credit scores are calculated and how you can easily increase your credit score. FICO develops the most popular versions of the credit score, used by most lenders to determine the creditworthiness of their loan or credit applicants
Get Free Weekly Credit Reports from the 3 Main Credit Bureaus until April 2021, Now Extended to April 2022
The Covid-19 epidemic has shut down economies all over the world. In the United States, with a 15% of the population has become unemployed, so many of them cannot continue to make loan payments, which can have drastic repercussions both for the unemployed and for the rest of the economy. Hence, the federal government has enacted new laws to improve the situation for those affected by Covid-19.
Federal Covid-19 aid programs are granting temporary payment relief for those with federally backed mortgages, which applies to most mortgages, and some types of federal student loans. Payments on certain types of federal student loans are automatically suspended until September.
However, pausing payments may cause significant damage to consumers credit reports, which may lower their credit scores significantly. However, a spokesperson at FICO said that the special payment arrangements will not lower FICO scores, which have recently reached a record high of 703.
These special federal safeguards do not apply to other types of loans such as auto loans or credit card debt. Consumers will have to contact their lenders to see if they will be allowed to suspend payments or lower payments for a duration. The consumer must get permission from the lender before lowering or suspending payments; otherwise, the account will be marked delinquent in the credit report, decreasing credit scores. Although consumers could add a statement explaining missed payments because of the COVID-19 epidemic, credit scores will still be impacted negatively, since it is not easy to evaluate explanations with computer algorithms.
The federal program has instituted safeguards so that if payments are paused, then those accounts with paused payments must be marked as current in the credit reports. However, there are bound to be mistakes, so the federal program also allows consumers to start checking their credit reports for free every single week. Previously, they could only check each credit bureau report once annually for free. Now you can get free credit reports from each of the 3 major credit bureaus every 7 days until April 2021, which has been extended to April 2022 on March 15, 2021.
Even before the COVID-19 crisis, Equifax agreed with the Federal Trade Commission as part of a settlement for a data breach in 2017 to provide 6 free credit reports annually until 2026, so this will continue after the program offering free weekly credit reports is ended.
When going to annualcreditreport.com, you will be asked to provide proof of your identity by answering security questions, so it may help to have several years of credit information available. Note that you may have trouble accessing your credit reports if you have a credit freeze on your account.
Credit scores can be computed in many different ways, and thus, there many different scores. However, all these scores are based on statistics and data analysis of credit reports and other related information. Their reliability in measuring actual creditworthiness is tested by studies that compares the actual future behavior of people, from a sample that is representative of the general population, with their credit score. The goal of any credit score model is to be able to identify as many people as possible that are good credit risks, while also identifying the bad risks. If the credit scoring model is too stringent, it may eliminate many people who are actually good credit risks, thus, decreasing profits to lenders because they are eliminating these potential customers who failed to pass the minimum score set by the lender. On the other hand, if the scoring model is too relaxed, it may give high scores to people who are actually poor credit risks, and this, too, will decrease profits for lenders, because they will lend money to many people who will default. Thus, the value of credit scores to lenders, and why they prefer one score over another, is the predictive value of the score in assessing the creditworthiness of people — to know who will probably repay their loan, and who will default. In other words, they can know that, for instance, 6% of the people with a particular credit score will default on their loan, but only 2% of the people with a score of at least 700 will default. This allows lenders to measure risk accurately, which, in turn, allows them to maximize their profits.
Thus, lenders use credit scores to qualify loan applicants and to determine what interest rate to charge. A higher credit score indicates a lesser credit risk, and therefore lenders will be willing to charge a smaller interest rate for your business. A lower score indicates a greater credit risk, and thus, if lenders even lend you the money, they will charge a higher interest rate on a loan to compensate them for taking a greater risk. This is like the interest rate that bonds pay — bonds with a lower credit rating must pay a higher interest rate to compensate investors for the greater risk of default. As a number, scoring allows companies to set standards, such as requiring a minimum credit score to be considered for a loan, and it allows computerized systems to screen for all people above a given credit score, to send out solicitations for credit cards or for insurance, or to offer tiered incentives, with customers with the highest score, being offered the lowest interest rate. Without a credit score, each credit report would have to be examined in detail, consuming time and resulting in different evaluations of credit based on the personal judgment of the person examining the credit report. Thus, credit scores save time and money for the companies using them, providing greater consistency by using a specific model to calculate the credit score. This makes credit decisions faster and fairer. Because the credit score is continually updated as new information is added to the credit report, recent items have more significance than older items. Thus, payment problems in the past become less important if current payments are timely. This enables a consumer to raise his score if he starts paying promptly consistently.
Credit scores can differ for the same individual because each of the 3 major credit reports differ slightly in some of their details, because credit scores from different companies use different algorithms in computing the score, or because the score was computed for a specific objective, such as car loans, credit cards, mortgages, and insurance, where different scoring algorithms by the same company are used that purportedly better predict creditworthiness for specific types of applications. Just as lenders can use different scoring systems or industry specific scores, some lenders may also use older versions of scores, which will yield a different score for the same credit file. For instance, older FICO scores weighted credit counseling for the consumer as a negative item while newer scores treat it as neutral.
Although credit scores are not hard to compute, since most are based on obvious factors, such as payment history and debt load, lenders have gravitated to widely used scores, such as the FICO score, because it was based on many credit customers, which allowed the Fair Isaac Company (the company has changed its name to its most famous score, FICO), the developer of the FICO score, to better predict creditworthiness according to their formula. In 2020, FICO also developed the FICO Resilience Index to rank credit applicants as to how likely they are to become delinquent during economic downturns.
Credit scores were developed in the 1950s, but lenders typically used their own credit scores to evaluate their borrowers. However, it was natural that, eventually, a national score would be used, since it could be based on much greater information that spanned large geographical areas. A credit score based on a larger database will generally be more accurate, since it draws on more information, and tracking the predictive value of the score is more comprehensive. Statistically, a larger sample is more predictive of the population.
Additionally, using a nationally well-known score permitted easy comparisons among different borrowers across different lenders and geographic regions. For these reasons, the FICO score has been established as the primary score used by most lenders and has continually increased its market share since its inception in 1956, and was given particular prominence when Freddie Mac and Fannie Mae, 2 government entities that bought most of the mortgages from primary lenders, started requiring lenders to use the FICO score in 1995.
Because of the prominence of the FICO score, and because most credit scores depend on the same or similar information, this article will focus on the factors that determine the various versions of the FICO score. For additional information on the different types and versions of credit scores, see Credit Score Types and Versions: FICO Scores, VantageScores, and Others.
Free credit scores can now be obtained from several credit card issuers, financial institutions, nonprofit credit and financial counseling providers, and other companies. The Consumer Financial Protection Bureau has provided a list of these companies here: A new list identifies more ways to access credit scores — for free | Consumer Financial Protection Bureau
Credit Reporting Agencies
Credit reporting agencies (a.k.a. CRAs, credit bureaus) gather credit history information about consumers and businesses, held in millions of files, and provided to credit grantors for a fee. These credit files hold information about payment history, total debt, length of credit history, types of accounts, and recent credit inquiries. Although there are many credit bureaus, most lenders rely on 3 of the major players:
The major credit reports have the following information:
- Payment history submitted by lenders, leasing companies, and other creditors, grouped under the following categories:
- 30 days late
- 60 days late
- 90 days late
- 120 + days late
- Unknown (X)
- Not reported (N/R)
- Total credit available and used by the consumer.
- Unpaid medical debt more than 180 days delinquent from date of service and delinquent debt from cable and phone bills and other utilities.
- Inquiries from creditors for credit reports based on the consumer requesting credit or applying for a service requiring regular payments.
- Public information like:
The information in credit files is used to gauge the probability that the borrower will repay any loans. This probability is represented by a credit score, of which there are many, but the most important credit scores are those developed by the FICO corporation, formally known as Fair Isaac Corporation. FICO scores are the most important because most lenders use them to determine whether to extend credit and other types of loans to applicants. Based on their experience, lenders consider FICO scores to be more reliable in predicting future repayment behavior. Payment history and total debt are considered the most important factors in all credit scores, as these are the best indicators of credit and default risk.
Credit files also provide information to calculate other types of scores for specific purposes, such as insurance scores and tenant scores. Insurance companies use insurance scores to determine whether to approve an applicant for insurance, because applicants with low scores will be more likely to file claims. Tenant screening is used by landlords in selecting tenants, since low scores indicate a higher probability that rents will not be paid on time or at all. Most kinds of credit file scores use the information in the credit files because it is convenient, but they differ in the weight given to each factor. Nonetheless, people with high credit scores will also have high insurance scores and other types of scores based on credit file information.
Many different types of businesses can access consumer credit reports including:
- Lenders and leasing companies
- Government agencies for determining eligibility for government assistance
- Landlords and residential real estate management companies for tenant screening
- Virtually any business that accepts personal checks, for check screening
- Debt buyers and collectors
- Insurance companies, to determine loss risk
- Communications and utility companies
- Retail stores that want to prevent product return fraud and abuse as well as rent-to-own businesses
- Gaming casinos who extend credit to consumers or accept personal checks
- Companies who market products and services targeted to subprime credit applicants
Under the Fair Credit Reporting Act, consumers have the right to see a copy of their current credit report from any agency that holds such a report and to dispute any items they think is inaccurate.
FICO Credit Score
Although there are many credit scores, the most common credit scores used by lenders are those calculated by the FICO algorithm. Common FICO scores range from a low of 300 to 850, with a score above 800 being exceptional, while a score below 600 is deemed fair or poor. However, lenders will differ in how they interpret the score. Many banks and credit card issuers participate in FICO Score Open Access, which allows them to offer your FICO score for free, if you are their customer. FICO also provides a free credit score estimator: Free Credit Scores Estimator from myFICO.
FICO has published a list showing the relationship between credit score ranges and creditworthiness:
- Poor: below 580
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800+
FICO also has industry-specific FICO scores, such as the FICO Auto Score and the FICO Bankcard Score. Unlike the base score, which ranges from 300 to 850, the industry-specific scores range from 250 to 900. However, what is considered to be a good score, a poor score, or an exceptional score is the same for both score ranges. The poor and exceptional ranges simply have a greater range of scores under the expanded score system, with a poor rating ranging down to 250 instead of 300 and the exceptional rating ranging up to 900 instead of 850.
According to FICO, FICO scores are used by 90% of the top lenders. As of 2021, the most common base FICO score is the FICO Score 8. However, FICO Score 9 has just been released, along with new industry-specific scores based on the FICO Score 9 algorithm.
Average FICO Score 8 by age:
- 18 to 29: 659
- 30 to 39: 677
- 40 to 49: 690
- 50 to 59: 713
- 60 to 99: 747
Factors that Determine the FICO Credit Score and their Relative Importance
Your FICO scores only depends on information in your credit reports, and the same factors will have different weights depending on your credit profile. Nonetheless, it is easy to see why these factors affect your score, so the exact method of calculating the score is not all that important.
Payment history includes whether required payments were made on time, and if they were late, by how much. Were the delinquencies recent? More recent information lowers scores more than older items.
Bankruptcies, judgments, suits, liens, wage attachments, and other signs of financial problems found in the public records will also have a negative impact, although, as with late payments, recent activity has greater weight than older items.
The greater the number of past due items, the more it will decrease your credit score, and the greater the number of accounts promptly paid, the more it will benefit your score.
Positive payment information in the credit file can be retained indefinitely. However, negative information, such as late payments or delinquencies, have a 7-year time limit, after which the negative information must be removed from the credit file. The only exception is a chapter 7 bankruptcy, which can be listed for 10 years after the filing date.
Sometimes payments are not made because they are disputed. If the dispute is not resolved, then you have a right to add a statement in your credit report, limited to 100 words, explaining why you refuse to pay. Note, however, that your statement will not protect your credit score, since explanations cannot be quantified, so the credit-scoring algorithm cannot take your statement into account. It will, however, take in account that you have missed a payment.
Fannie Mae Starts to Use Trended Credit Data to Underwrite Consumers
In mid-2016, Fannie Mae started using trended credit data from all 3 credit reporting agencies — Equifax, Experian, and TransUnion — for all mortgage applications. The trended credit data focuses on credit data from the past 30 months, showing not only if payments were made on time, but whether the borrowers carried balances from month-to-month, paid off the balances in full, or at least paid more than the minimum. Studies by TransUnion have shown that consumers who carry balances or who only pay the minimum balance are a greater risk than those who pay in full. TransUnion estimates that trended credit data will put more consumers, from 12% to more than 21%, in the so-called Super Prime risk tier, who are offered the best credit terms.
Fannie Mae to Consider Rent Payments to Assess Creditworthiness
9/12/2021. The Federal National Mortgage Association (Fannie Mae) was created by the federal government to help low- and middle-income people to buy homes. To further that interest, Fannie Mae is changing the standard for who qualifies for a loan by allowing people to use their record of rent payments as a means to establish creditworthiness. Because landlords do not regularly report to credit bureaus about rent payments, the borrower would have to allow Fannie Mae to access their bank accounts that were used to make the rent payments.
Fannie Mae estimates that 17% of the people who haven’t owned a home in the previous 3 years, and would not have qualified otherwise, will now qualify under the new standard. This will help roughly 20% of Americans who, according to the Consumer Financial Protection Bureau, have no or limited credit histories.
Amount of Debt
Your total debt as a percentage over your total credit — your credit utilization ratio — is a significant factor. The greater the debt, the lower your score. Thus, the more money owed on each account, and the more accounts with high balances, the lower the score. And since the amount of credit on each account is typically limited by what you are able to pay, a high ratio of account balances to total credit will also lower your credit score.
The credit utilization ratio is calculated by dividing the outstanding balance on each revolving credit account by the credit limit. If the creditor does not report the credit limit to the CRA, then the highest reported balance is used, which may reduce your score significantly if you charge the same amount every month. If the account is an installment loan, such as a mortgage or auto loan, then the payoff rate is used, which is the amount outstanding divided by the original amount of the loan.
However, it is not just the amount owed on all accounts that matters, but also the amount owed on different types of accounts, such as revolving or installment debt. Though lower credit utilization ratios will increase your score, according to FICO, using at least some of your credit will be more positive than not using any of your available credit. For installment loans, the remaining debt is compared with the original balance. Note, however, that paying off the balance will slightly lower your credit score if it is already high, if you are paying off a loan for which you only have a single type, such as an installment loan, since this reduces your credit mix.
One thing to note about credit utilization is that since it is assessed monthly, your credit score will change as your credit utilization changes. This differs from payment history, since late payments can hurt your credit score for several years.
Important Note about Medical Debt
According to Experian (https://www.experian.com/blogs/ask-experian/medical-debt-and-your-credit-score/), most healthcare providers do not report to credit bureaus. Only when the debt is sold to a collection agency will that debt begin to appear on your credit report.
However, even if your medical bills do go into collection, all 3 credit reporting agencies will give you a 180-day waiting period to resolve any medical debt before the account even appears on your credit history. Until then, that medical debt will not impact your credit score at all, since it will not be in your credit reports.
Length of Credit History
A longer credit history has greater predictive value, and thus, will have a positive effect on your score. The weighting of the length of credit history depends on how long your credit accounts have been established, the age of your oldest account, the age of your newest account, and the average age of all of your accounts. It also depends on how long it has been since you used these accounts.
How many and what type of accounts you have recently opened affects your score. Credit inquiries are listed in your credit report every time a lender looks up your credit report because you have applied for a loan or credit. A greater number of recent inquiries lowers your score because applying for many loans within a short time can make you look desperate for money; thus, indicating a significant credit risk. On the other hand, developing a positive credit history after some delinquencies, or even a bankruptcy, will help to increase your score, because more recent items are more important than older items.
Types of Credit Used
The nature of your accounts — mortgages, credit cards, retail accounts, installment loans, and consumer finance accounts — will also have some impact, as this will indicate how much experience you have in dealing with different types of accounts. Accounts with consumer finance companies will lower your score. Installment loans are a good indication of creditworthiness because lenders scrutinize the consumer more thoroughly, gathering additional information besides the credit score, such as income and job stability. So getting approved for an installment loan will usually improve your credit score.
Because credit inquiries have an impact on your credit score, it helps to understand a little more about credit inquiries. Credit inquiries are categorized as a type of new credit because these inquiries result from your applications for new credit, which accounts for about 10% of the total score, although the exact percentage will vary according to the individual. Because there is little else to consider, credit inquiries will account for a bigger percentage of the score if you have few accounts or a short credit history. A credit inquiry is recorded when someone asks for your credit report from one of the credit reporting agencies. The Federal Fair Credit Reporting Act (FCRA) restricts access to your credit report to people or organizations having a permissible purpose — as defined by the FCRA — including credit card and insurance companies, banks, landlords, and any other business, organization, or person with a legitimate need to know your credit history, and this need can only exist if you apply for what they have to offer — a credit card from a bank or place to rent from a landlord, for instance. Insurance companies are using a variation of the credit score — often called the insurance score — to evaluate potential risks. People with low scores tend to file more claims, and thus, the insurance score is used to screen out such people, or to charge them higher rates.
Employers can access your credit report only with your permission. Usually, only employers seeking to hire for important positions, which require integrity or where there are security concerns pull credit reports. Banks, for instance, will generally look at credit reports for potential hires. Inquiries by employers will appear in your credit report, but will not lower your score.
Anyone who obtains a copy of your report under false pretenses can be fined substantially and jailed for up to two years.
There's a section on your credit report that lists everyone who accessed your report in the last 2 years. However, only the previous year is considered in the FICO score.
There are 2 types of inquiries to your credit report: hard and soft. A hard inquiry results because of some action that you have taken with a business, and that business wants to check your creditworthiness. To gauge this, the business will request a credit report from any or all the CRAs, and this inquiry will be listed in requested reports. A soft inquiry is either not listed or not counted in evaluating your score.
Promotional inquiries — when businesses do a credit check to send you pre-approved offers of credit or insurance — is a soft inquiry, which does not affect your score. Administrative inquiries from a company that you are already doing business with also does not affect your score. Requesting your own report is also a soft inquiry, so it doesn't hurt to look at your credit report periodically, which you should do to find and correct any mistakes.
Removing your Name for Prescreened Credit Offers and Other Promotions
If you want to remove your name from prescreened, pre-approved promotional offers for credit or insurance based on your credit report from Experian, Equifax, TransUnion, and Innovis Data Solutions for 5 years, call (888) 5-OPTOUT — (888) 567-8688 — or submit your request online at OptOutPrescreen.com, the only website authorized by these credit reporting agencies for consumers to opt out of firm offers of credit or insurance. However, if you want to opt out permanently, fill out the Permanent Opt-Out Election form available at the website, print it, sign it, then mail it at the provided address. If, after opting out, you want to opt in again, you can do so at the website.
When you apply for a mortgage, car loan or other credit, a lender is authorized to request your credit report. This is a hard inquiry, and this type of inquiry can lower your credit score. However, there is a special situation where multiple hard inquiries will not hurt your score. These are inquiries for loans such as mortgages or car loans, where you certainly have a compelling interest to shop around for the best deal, and so may apply at several places, but you are obviously just looking for one loan. Such inquiries will be listed as only one inquiry if they occur within a short duration — 14 days for the Classic FICO score, 30 days for newer scores, and 45 days for the latest scores. (This process of listing multiple inquiries as 1 is called de-duplication, or de-duping, by the industry.) Many lenders continue to use the Classic FICO score.
However, not all hard inquiries are treated equally. The FICO score algorithms also considers inquiries that may affect your credit risk. Inquiries that will have little effect on credit risk will have lower weighting than the same number of inquiries with a potentially higher credit risk.
How Corporate Credit Cards Affect the Credit Reports and Credit Scores of Authorized Users
Corporate credit cards are often issued to employees as authorized users, so that the employee can pay and track expenses. Corporate credit card bills must be paid in full every month, so there is no accumulation of interest. With a corporate credit card program, either the company takes responsibility for timely payments, or assigns that responsibility to the employee.
If the company takes responsibility, it will generally pay the bill after the employee files an expense report; otherwise, the employee pays the bill.
When the corporation is responsible, then an employee's credit record and credit score will not be hurt if the payment is late. Even when the employee is responsible — 43% of the time according to 1 survey — the credit card companies may give the employee an extended grace period. For instance, American Express, the major corporate credit card issuer, won't report the delinquency for at least 180 days past the due date.
However, late payments can result in loss of rewards or require the payment of a fee to reinstate the rewards, or require payment of late, suspension, or reinstatement fees. It may also hurt the employee's relationship with the company, since it not only indicates that the employee isn't very responsible — a quality needed for most jobs — but the company may get less of a refund from the credit card company because of higher delinquency rates.
Credit Alert: Most credit card companies and other lenders report both on-time payments and delinquent payments. However, utility, cable, and cell phone companies, and landlords do not report on-time payments, but they do report delinquencies. Therefore, paying the bills from these companies on time or paying your rent on time will not increase your credit score, but delinquencies may damage it.
FICO also places different people into different groups known as scorecards, which group people according to their creditworthiness. This is done because the same behavior can be treated differently or scored differently according to the scorecard that the consumer is in. Thus, opening up several lines of credit within a short time would be seen as a much higher risk for someone in a low scorecard compared to someone in the highest scorecards. The FICO score used by most lenders has 10 scorecards, with 2 of the scorecards for people with significant credit problems. FICO 8 has 12 scorecards, 4 assigned to people with significant credit problems; FICO 9 uses 13 scorecards.
How Much Does a Negative Credit Event Lower FICO Scores
The algorithm used to determine the FICO score, which was developed by the FICO Corporation, is secret. However, MyFICO.com, which is maintained by the FICO Corporation, gives examples of the following negative credit events and their effect on the credit score of 2 hypothetical people, one with an initial score of 680 and another with an initial score of 780. Note that the higher the credit score, the greater the drop after a negative credit event.
|Initial FICO score||680||780|
|Maxing out a credit card||650-670||735-755|
|A 30-day delinquency||600-620||670-690|
|Settling a credit card debt||615-635||655-675|
The resulting credit score is given as a range because the actual score depends on the other information in your credit report. Paying off an auto loan or a mortgage will also lower your score if that was your only loan of that type. For someone with a credit score higher than 800, the drop can be 14 to 25 points. People with lower scores will not be affected as much.
People with lower scores tend to recover their initial scores after a negative credit event in a shorter time than consumers with higher scores, since scores drop less on negative credit events for those who already have lower scores than for those who have higher scores, and so it takes less time to recover the fewer points lost. For instance, if the negative credit event is being 30 days late on a mortgage, then the consumer with a 680 initial FICO score can recover that score in about 9 months, whereas another consumer with an initial score of 780 will take 3 years to recover the 780 score.
What does not Affect your FICO Credit Score
First, and foremost, most of the factors affecting your credit score are in your credit report, so any data that is not in the credit file will not affect your credit score. For instance, most liens or judgments are not recorded in credit files, since many of them do not have an associated Social Security number, so these records cannot be unambiguously assigned to a particular consumer, at least not by computer algorithms.
Any factor that is not permitted by law to be considered for obtaining credit cannot be used in calculating your credit score. The federal Equal Credit Opportunity Act prohibits discrimination based on race, color, national origin, religion, sex, or marital status. Receiving public assistance, renting, child support obligations, getting credit counseling, or exercising any consumer right under the Consumer Credit Protection Act also cannot be considered.
Your age (unless you're a minor) and where you live are not factors in your FICO score.
Salary, occupation, employer, date employed or even employment history are not used in calculating your score, but they will certainly be considered by any potential lenders of loans or credit cards that you apply for.
Judging Creditworthiness without Credit Files
Most people in the world do not have a credit file, so how can their creditworthiness be assessed? For people without an extensive credit history, credit bureaus are starting to use court records, and rent, utility and phone bill payments. New startups that are trying other methods of assessing the creditworthiness of people living in 3rd world countries, most of whom do not have credit files, are analyzing online social networks of loan applicants — with their permission, of course — such as professional contacts on LinkedIn, looking at the number and nature of LinkedIn connections to coworkers, and even rating the contacts of potential borrowers.
Some startups are also using statistics to spot other patterns that may indicate creditworthiness or the lack thereof. For instance, it was recently found by one company that loan applicants who type only in lowercase or uppercase letters are less likely to repay loans. Some data providers are also looking at connections on Facebook. Loan applicants with friends who have well-paid jobs and who live in nice neighborhoods are deemed to be more likely to be creditworthy. On the other hand, having friends who recently defaulted on loans is a negative. - Credit scores: Stat oil | The Economist
More recently, the CRAs and FICO have established an alternate way of assessing creditworthiness:
- Experian Boost allows people without a credit history to use their payment history for utilities, such as gas, water, and electric, Internet/cable, and telecom payments, accomplished by giving Experian read-only permission to see your bank account data. You decide how many such payments you wish to add to the Experian credit file. You can discontinue the service at any time. Experian Boost will not have much of an effect for someone who already has a pretty good score. According to Experian, which uses the FICO Score 8 Model for this program. scores were boosted by an average of 13 points, which is negligible. However, it may provide more of a boost with people who have no credit history.
- Experian Boost is free. You connect your bank account used to pay your bills, then choose to verify the positive payment history you want added to your credit file. If there is a boost, it will be instant.
- With FICO’s program, the UltraFICO Score analyzes your bank account to see how well you manage your money and other factors that affect your score, such as how long accounts have been open, frequency of activity, maintenance of a savings balance and the total savings, and the avoidance of negative balances, as may occur with bounced checks.
- FICO, in conjunction with Equifax, developed a score, called the FICO Score XD, which uses information in cell phone and cable accounts provided by Equifax and on property records and other public data provided by LexisNexis Risk Solutions.
- Developed by TransUnion, the CreditVision Link relies on data from payday loans, checking account histories, frequency of home address changes, as well as the size of monthly payments and whether the payments were increasing or decreasing while the loan is outstanding. The credit score range for both the FICO Score XD and CreditVision Link were the same as for the FICO score, 300 to 850, with higher scores indicating a better credit risk.
Improving your Credit Score
Now that you know what factors influence your credit score, it's easy to know what you can do to increase it. Pay your bills on time and lower your overall debt. This accounts for 65% of your score. A good way to always pay bills on time is to use automatic debit services, which almost every credit card company offers, nowadays. With automatic debits, the company automatically deducts the money from your checking or savings account, when it is due. You just have to ensure that there is enough money in the account. You can also take advantage of automatic payment services provided your bank. Almost every bank offers this now, and, usually, it's free. Oftentimes the bank can pay the credit card companies electronically, so if you owe a balance on your card, you can save some money by scheduling payment of your monthly bill at the beginning of the billing cycle instead of when it is due. This will save the monthly interest on that payment.
Don't necessarily close accounts, because they do give you some flexibility in meeting possible future financial problems, and having fewer accounts can actually lower your score, but do close any accounts that are charging a monthly or annual fee just to have the accounts. However, don't start applying for many credit cards, either, because each of these applications will be listed on your credit report as separate inquiries, which can make you seem desperate for cash — a possible sign that you are in financial difficulty, and thus, a poor credit risk. This is particularly true for new credit users, who don't have a long credit history. Build your credit profile slowly.
Should You Close Old Accounts?
There is advice — from the CRAs, no less — not to close old accounts, because a long credit history improves your score. But consider the following: Your credit score depends more on activity from the last 2 years, and all negative information older than 7 years, except for Chapter 7 bankruptcies (10 years), must be expunged from your credit file. Furthermore, even if you close an account, the account information will remain in your credit report for 7 years, so even closed accounts provide credit information. And while having many open accounts with little debt helps to improve your score by lowering your credit utilization ratio, lenders may see this as a danger sign that you can take on too much debt later on. Additionally, credit history only accounts for 15% of the FICO score.
There are at least 2 measures of account age: the age of your oldest open account and the average age of all of your accounts. Therefore, it does make sense to keep your oldest account open, unless there is a compelling reason to close it. How the closing of an account will affect the average age depends on the number of accounts and their ages, but generally, the impact of closing 1 account will be inversely related to the number of remaining accounts. So the impact of closing 1 account will be lower if there are many remaining open accounts rather than few, unless the closed account is much older than the remaining open accounts.
Note, also, that whether an account is closed by you or the lender does not affect your score. A closed account may lower your score because it lowers your total credit available and increases your credit utilization rate, but the credit scoring algorithms do not consider who closed the account. But if the account was closed by the lender for a delinquency, then the delinquency will be in your credit report and will lower your score.
Nonetheless, any impact of closing accounts because of credit availability may be short-term, because lenders determine credit limits by considering how much credit you have available. You may receive higher credit limits on your other cards by closing some accounts, so your available credit may increase after lenders review your account, as they do periodically, so any impact of closing old accounts may quickly decline.
The upshot is that closing less desirable accounts probably will not lower your score much, if at all, especially after a few months have elapsed since the closing. If you are not using a credit card or using it minimally to prevent closure from inactivity, then consider:
- Are you paying an annual fee?
- Does the account charge a high interest rate?
- Can you replace old cards with new cards from the same issuer that have more rewards or lower interest rates?
- Are you incurring an opportunity cost by not using cards with better rewards just to prevent closure of the old account from inactivity?
Another factor is the amount of debt on each line of credit compared to the credit limit for that account. Maxed-out accounts lower your rating, even if you have other accounts with a zero balance. (I also find this puzzling. If you have just 1 or 2 accounts that are maxed out, it may be because you transferred balances from credit cards charging a higher interest. This would be the intelligent financial move to make, so it makes no sense that it should lower your score! However, the more accounts that are maxed out, the lower score, since this generally indicates that you are having financial difficulty.)
Free Credit Freezes and Fraud Alerts Are Now Available
Identity theft often leads to errors in credit files, reducing the reported creditworthiness of the consumer affected. Credit freezes can mitigate some of the negative effects of identity theft. Credit freezes, also known as security freezes, restricts creditors or potential creditors from accessing your credit file. Previously, the credit bureaus charged fees for credit freezes, but as of September 21, 2018, a new federal law now allows these credit freezes to be free. You can also get a free credit freeze for your children younger than 16. Guardians and conservators, and those with power of attorney over others, can also obtain a free freeze for their charges.
Additionally, consumers can also apply for 1-year fraud alert on their credit files, which would require potential creditors to contact you 1st before extending any new credit. Previously, fraud alerts only lasted 90 days. Victims of identity theft can also get a free fraud alert that can last for up to 7 years. Members of the military can also place active-duty alerts for 1 year that can be renewed during deployment. An active-duty alert will also remove the name of the military member from marketing lists for up to 2 years unless the member requests otherwise.
Credit freezes and fraud alerts can be implemented by contacting the 3 major credit reporting agencies online or by phone, and they must be implemented within 1 business day, and if you request a lift of the credit freeze or fraud alert, then the credit reporting agencies must respond within 1 hour. However, if the request is made by mail, then the credit reporting agencies have 3 business days to place or lift the freeze.
If you think that the credit reporting agency is not issuing the credit freeze or fraud alert after your request, then you can file a complaint with the Consumer Financial Protection Bureau.
History: Piggybacking — Improving Your Credit Score by becoming an Authorized User
Prior to September, 2007, there was an unusual way to improve someone's credit score by making that person an authorized user of a card where the legal owner of the account had a long and good payment history with that card — termed piggybacking, or, as FICO calls it, tradeline renting. This worked because the FICO algorithm treated the entire payment history as if it was the authorized user's own credit card. Hence, it was used to quickly raise the score of children who started to use credit, or for family members or friends emerging from bankruptcy.
The disadvantage for the legal card owner was that the authorized user might run up excessive charges on the credit card, especially since the user had no legal obligation to pay the bill. One ploy to prevent this is to not give the authorized user a card.
There were even some websites that charged $1,000, or more, for this benefit. These websites also offered other credit services as well, although I don't know if they would be in the best interest of those seeking to rebuild their credit. Indeed, advertising the raising of credit scores may simply be a way to attract credit seekers to their other services. To pay so much money to raise one's score is a good indication that the person is not financially wise, and thus, is bound to have a lower credit score eventually, anyway.
Piggybacking was also disadvantageous for the authorized user. If the legal card owner would stop making timely payments on the card — for instance, because of an unanticipated hospitalization — this would negatively affect the credit rating of the authorized user.
The credit rating of the authorized user has no effect on the legal owner's credit record or rating, since it is the owner who is liable for the card.
Alas, piggybacking as a means of increasing one's credit score is now history. According to this New York Times article, Ron Totaro, vice president for global scoring solutions at FICO, has indicated that, starting in September, 2007, the FICO scoring algorithm will no longer include authorized user accounts in its formula for calculating FICO scores.
However, new information from FICO is showing that the new FICO 8 score still considers authorized user accounts, but only if the authorized user is related to the account owner. This is to reduce any benefit of piggybacking.
Correcting Mistakes in Credit Reports
It is important to periodically review your own credit reports from each of the major credit reporting agencies, not only because mistakes can creep into the report, but because identity theft can ruin your credit. A 2015 FTC report showed that 25% of credit files had errors in them and 5% had errors significant enough to lower their credit score.
Errors in credit reports include:
- clerical errors in reading or entering information from applications;
- loan payments being applied to a wrong account;
- accounts being reported more than once;
- leaving negative items on the report longer than legally allowed;
- negative information from a divorced spouse remaining on the account;
- mysterious accounts and negative items from identity thieves using your personal information when applying for credit.
Now you can get your credit reports free of charge at AnnualCreditReport.com, which is a centralized service for consumers to request free credit reports (aka credit file disclosures). It was created by the 3 nationwide consumer credit reporting companies, Equifax, Experian and TransUnion. Under the Fair and Accurate Credit Transactions Act (FACT Act or FACTA) consumers can request and obtain a free credit report once every 12 months from each company. You can also dispute credit information at this secure site. If you live in California, Colorado, Connecticut, Georgia, Maine, Maryland, Massachusetts, Minnesota, Montana, New Jersey, Vermont or the Virgin Islands, you are entitled to at least 1 more free copy from each credit bureau per year.
Although the law gives consumers the right to challenge incorrect information on their credit reports, the credit bureaus make it difficult to actually correct the information. A new report by the Consumer Financial Protection Bureau (CFPB), published in December 2012, shows that it was still difficult to get errors corrected, since the credit bureaus often ignore consumer challenges to the information in the report. Hopefully, the CFPB will change this. However, a recent article, An $18 Million Lesson in Handling Credit Report Errors - NYTimes.com, published on 8/3/2013, shows, in detail, why it is still difficult to get the errors corrected. Most of these errors arise because the credit bureaus accept reports with incomplete information from lenders, such as accepting information where only 7 of the 9 digits in a social security number match. Sometimes this leads to a mixed credit profile, where a negative report is inserted into the record of someone with a similar name or Social Security number. The credit bureaus accept incomplete information to fulfill an attempt to provide a complete record on the consumer. They argue that as long as other information matches the record of the consumer, mistakes will be relatively rare. The credit bureaus have also largely automated the error correction problem, but their system doesn't allow much flexibility due to its poor design. No doubt this state of affairs continues because the credit bureaus earn no income from correcting mistakes, so they try to minimize costs in every way possible, and being an oligopoly, they have no concern about losing market share, especially since consumers are not their market!
Indeed, if a negative item is reported because of identity theft, the burden of proof is on the consumer to show that he did not open the account and was not responsible for the reported item. Even when the consumer disputes an item, the credit bureau only sends a 2-or 3-digit code indicating a brief summary of the dispute to the creditor who reported the disputed item. The credit bureaus do not send any of the documentation that consumers often send them to prove their case, which makes it more difficult for the creditor to ascertain the validity of the dispute.
If the dispute is not resolved, the Fair Credit Reporting Act does allow consumers to sue the credit bureaus, but such cases can take years to resolve. Moreover, if consumers try to resolve the dispute with the lenders, then they will lose their right to sue the CRAs in court. The rationale for this provision is that allowing consumers to sue lenders would discourage the lenders from providing information to the credit bureaus, which would make it difficult to ascertain the creditworthiness of the consumers.
Here are some steps to take to fix credit report errors:
- Fixing the error at one credit bureau does not fix the error in the others, since they do not communicate with each other regarding errors in their credit files. If you find any errors in any of your credit reports, then you should contact all of the credit reporting agencies, since they may have the same error.
- Gather all available evidence, including account statements and payment records. Without evidence, the credit bureaus can claim that your dispute is frivolous and then just dismiss it.
- Maintain all records of your communication with both creditors and the credit bureaus. If you interact with them on their websites and take screenshots of important information. If you call them on the phone, then record the conversation. Some states require that you notify and get the consent of the other party of the recording, but many businesses notify you that they are recording the conversation, so do the same, notify them that you are also recording the conversation. If the business does not state that it is recording the conversation, then just state that you are recording the conversation. If they continue talking, then that is prima facie evidence that they accept the recording. Recordings are usually governed by local law, so contact your attorney if you have any doubts.
- Mail all materials by certified mail with return receipt. Keep your own copies. The credit bureaus have 5 days to send the disputed information to the financial institution. If the lender does not investigate and respond to the dispute in time, then you can go to court to force the credit bureaus to delete the information.
- Try to discover what caused the error to ensure that it does not recur.
- If the credit bureaus correct the errors, then they must send an updated credit report to anyone who’s checked your credit within the past 6 months.
- You can sue credit bureaus or financial institutions for credit reporting errors that they refused to correct, and if you win your case, your legal fees will be covered. You can find an attorney at the National Association of Consumer Advocates (consumeradvocates.org). Most consumer advocate attorneys will review your case for free, and they can assess the strength of your case.
- If you are a victim of identity theft, then you have the right to obtain detailed documentation about the accounts opened by the thief.
Additional Tips and Resources for Improving Your Credit Score
- Get a free credit report at AnnualCreditReport.com every 4 months by requesting a report from only 1 credit reporting agency at a time — a good, free way to monitor your credit report.
- Some credit cards offer free credit scores that are updated monthly. For instance, Discover Card provides a free FICO score based on your credit information held by TransUnion. Even if the credit card does not provide a FICO score, any score can be used to monitor changes in your credit information by checking for monthly changes in your score. Credit scores often change by 10 to 20 points during the month, but if you notice larger changes in your score during a time when there was no significant credit event, you may want to check the credit report from the agency on which the score is based for errors or for possible identity theft.
- As of November, 2015, you can upload supporting documents, such as paid bills or canceled checks, to support your credit dispute. Source: Fixing Credit Report Errors Online Gets Added Heft - The New York Times
- File a credit reporting complaint with the Consumer Financial Protection Bureau.
- Sample Letter for Disputing Errors on Your Credit Report with Information Providers. See also Disputing Errors on Credit Reports by the FTC.
- If you want to send a letter to the CRAs that may lead to legal action, then send it as certified mail with return receipt.
March 9, 2015 update: The credit bureaus use automated dispute resolution processes to correct errors reported by consumers, which is why mistakes in their credit reports frequently go uncorrected. In their settlement with the New York Attorney General's office, with changes being phased in over the next 3 years, the 3 credit bureaus will provide specially trained employees to resolve disputes. Additionally, the credit bureaus will establish a 6-month waiting period before listing medical debt, and any such debt that was reported, but subsequently paid by insurance, will be removed. - TransUnion, Equifax and Experian Agree to Overhaul Credit Reporting Practices - NYTimes.com
Ways to increase your credit score include:
- Pay your bills on time.
- Keep credit balances low.
- Don't cancel unused cards without a good reason, such as an annual fee, since this both increases your credit utilization and decreases the average age of your accounts.
- Maintain several types of credit, such as credit cards, an auto loan, and a mortgage.
- Don't apply for several credit cards at once, since it can make you look desperate for money and can lower the average age of your accounts, both of which lowers your score. However, multiple requests for a single type of loan, such as a mortgage, auto loan, or student loan, within a 45-day period will not lower your score, since the assumption is that the consumer is shopping around for the best loan.
- Monitor your credit reports regularly. Major errors to look for include:
- duplicate credit accounts,
- bad debts older than 7 years,
- debts incurred by a former spouse or someone with a similar name.
Here is what does NOT hurt your credit score under more recent scores, although some of these may still lower your score under older FICO algorithms, which some lenders still use:
- Unpaid parking or traffic tickets are no longer collected by any of the credit reporting agencies, so they no longer lower your score.
- Credit reporting agencies also no longer collect information on current or unpaid library fines.
- Most liens or judgments are not recorded in credit files, since many of them do not have an associated Social Security number, so these records cannot be unambiguously assigned to a particular consumer, at least not by computer algorithms.
- You may check your own credit report as much as you like, without lowering your score.
- Employers, insurance companies, and landlords can only access your credit report with your permission, and if they do access the report, it will not lower your credit score, since, unlike applying for credit cards, these are not applications for credit.
- Under the most recent FICO scoring algorithms, debts held by a collection agency that were paid off will no longer lower your score.
Should You Buy Your Credit Score?
Unlike credit reports, credit scores were not generally free. Indeed, they were a very profitable business for both the credit reporting agencies and FICO. In fact, FICO set up a site specifically to sell consumers their FICO credit scores at myFICO. Some other websites also try to sell credit scores, but buying them is no longer necessary.
FICO has an Open Access Program that allows card issuers, such as Discover or American Express, to show FICO scores to their customers for free. So if you have such a credit card, then you can see your FICO score based on information supplied by a particular CRA, which will be listed by the credit card issuer. Additionally, since July 21, 2011, the Dodd-Frank Act requires that lenders give loan applicants who were turned down for a loan or job applicants who were turned down for a job the credit score that the lender or employer used in its decision.
In certain cases, such as when shopping for a mortgage, it will be useful to know your scores from all 3 CRAs. Most lenders charge an application fee that could be hundreds of dollars, so knowing your score can help you to assess whether you have a real chance of getting a mortgage from a particular lender. A higher score will generally mean a lower interest rate and lower monthly payments. However, to get any real benefit from knowing your score, you will need to know which scores lenders are getting. I believe the FICO score will remain the favorite of lenders since it is well tested. Lenders generally get 2 or 3 scores. If you do get your scores and 1 score is significantly lower than the others, check your credit report from the agency with the low score to see if there are any mistakes in the credit report. And if you are shopping for an auto loan or a mortgage, check all 3 credit reports, anyway. The only way to correct mistakes, which will raise your score, is by actually looking at your credit reports, and disputing anything that is not correct. Since correcting mistakes generally takes a least a month, it's best to start at least several months before shopping for a loan.
If you are not shopping for a mortgage or any other loan that requires an application fee, don't waste money on getting your score, especially since lenders will not rely only on your credit score. Income and job history will be just as important, if not more important. Because the score depends mostly on information in your credit report, knowing the contents of your credit report will give you a good idea of your score — whether it is high, low, or average. Another way to know is if you are getting a lot of solicitations — unless you have opted out — from credit card companies. The fees in these offers will indicate whether your score is high or low. If there are many regular fees (not including penalty fees), such as an annual fee and a monthly fee, for instance, or a security deposit is required, then your score is probably low. For someone with a low credit score, these fees can be very high, and the consumer would be foolish to respond to such offers. Remember, your credit score and your credit report are derivatives of your creditworthiness. By learning to avoid rip-offs, by learning how to save money on purchases, and to buy only what is needed and can be afforded, and paying your bills on time, you can be well on your way to raising your credit score, even without knowing the actual number.
How Bankruptcy Affects Credit Scores
A Chapter 7 bankruptcy can be listed in credit reports for up to 10 years from the date that the case was filed, and a Chapter 13 bankruptcy can be listed for up to 7 years after filing. Note that because a Chapter 13 case usually takes 3 or 5 years from filing to discharge, a Chapter 13 bankruptcy can only be listed in credit reports for about 2 to 4 more years after the final discharge.
It might be surprising to learn that bankruptcy doesn't really hurt most people's credit that much. This is because bankruptcy discharges most unsecured, nonpriority debts, including almost all credit card debt, collections, and court judgments, and the consumer will not be allowed to file another bankruptcy case for years. Thus, the consumer becomes a better credit risk. Moreover, people who file for bankruptcy already have bad credit, with missing or late payments, collections, judgments, and other negative items in their credit files. Furthermore, bankruptcy places a definite time limit on accounts. In other words, a delinquent credit card account will be listed in credit reports for up to 7 years after the account is closed! If the account is never closed, then it can remain on the credit report indefinitely. Bankruptcy puts a definite limit on how long discharged accounts can remain in the file.
After bankruptcy, if the consumer is wiser financially and is diligent in making payments, his credit will improve greatly over the 2 years following the final discharge, since credit scores depend mostly on financial data accumulated over the past 2 years, with more recent data having more influence on the score.
Anyone receiving a bankruptcy discharge should review all 3 credit reports after the discharge to verify that all discharged debts have been listed as "Included in Chapter 7 Bankruptcy" or "Included in Chapter 13 Wage Earner Plan," depending on which type of bankruptcy was filed. If any discharged debts are not listed as such, then the credit reporting agencies should be notified, so the debts can be properly listed as discharged. Because bankruptcy petitions are public records, the credit reporting agencies must list the debts as being discharged, since there can be no dispute about the facts. For more information on how bankruptcy affects credit scores and how to improve your credit score after a bankruptcy, see Credit Availability and Credit Scores After Bankruptcy.
The Best Way to Raise Your Credit Score Is to Be Financially Responsible and Financially Wise
Being both financially responsible and financially savvy is the best way to increase your credit score. Being financially responsible means paying your bills on time, and not going too far into debt in relation to your income. When you don't pay your bills on time, it means that either you are not organized and responsible, meaning you will not be reliable, or you are in financial trouble, so you are a greater credit risk.
Being financially savvy means that you know how to earn, save, and invest money. While this document certainly can't cover such a broad subject, it is actually the most important determinant of your creditworthiness — its very foundation!