Your Credit History, Credit Score and Why It Matters
So often I talk with individuals who would really like to buy a new home but just don’t have their credit in a place where borrowing money is do-able. Having spent a long career in the banking world, I’ve come to understand credit better and have seen time and time again where it has the ability to help people, hurt people and cost people.
Many money gurus like Dave Ramsey and Suze Orman will tell you only to buy things using cash which sounds great and is great advice. The truth is that the majority of us will never know what it's like to buy a home with cash.
There are numerous credit scoring companies each with their own algorithms as to how they determine your score. These algorithms are not meant to be understood by the public because they tend to change frequently- and usually do not benefit you as the consumer.
The three major credit reporting agencies are Experian, Equifax and TransUnion. They are all very similar however there may be creditors that do not update or report to all three which mean there could be inconsistencies.
Before we dig in to look at the various aspects of credit, I want to make something abundantly clear- YOU ARE NOT YOUR CREDIT.
Lenders, other Realtors and maybe even your parents will rate and judge you by your credit. My experience has shown that tThe stories and circumstances are endless. Everyone has a history and some are cleaner than others but your worth as an individual is not determined by your score.
A credit report is a long form representation of the credit accounts of an individual. It reports and maintains credit information usually for 7-10 years depending upon the type of impact it has and consists of the following information:
1. Identifying information - Name (previous names, maiden names), address, previous address, employer,
social security number and birth-date).
2. Tradelines - The name and account number of any creditor that has issued credit to you.
3. Type of account - Installment loans, auto loans, mortgage loans, credit lines.
4. Dates - When an account was opened or closed.
5. High credit amount - The highest credit limit granted by the creditor.
6. Current balance - The balance outstanding at the time the report was most recently updated.
7. Late payment history - Indicates a history of on-time payments or payments made 30,60 or 90+ days late.
8. Credit inquiries - This includes inquiries made prospective creditor (hard inquiry) in addition to inquires by
you, an existing creditor or a marketing company (soft inquiry).
9. Public records and collections bankruptcy, repossessions, and foreclosures are pretty Self-explanatory.
A credit score is a numerical representation your credit report. Scores range from 350 to 850 with the higher number being better. Since different creditors report to different credit bureaus, most mortgage lenders will compile what they call a "tri-merge" and pull all three. They will either use an average or the middle number. In general, most lenders will look at your credit score and place you in a certain category:
720 or higher: Excellent
660 - 719: Average
620 - 659: Poor
620 or lower: Bad
35% of your credit score is calculated based on your payment history. This is a calculation of how timely parents are made.
30% of your credit score is calculated based on your capacity. Capacity, in this case, is the difference between what you owe and your high credit limit. For example, a credit card limit of $5,000 with an outstanding balance of $0 would indicate a larger capacity and thus a greater positive impact on your score. If you had a credit limit of $5,000 and an outstanding balance of $4,900- your capacity would be diminished and it would have a negative impact on your score.
15% of your credit score is calculated based on the length of credit. This would be how long you've had active trade-lines. A tradeline would be a particular creditor. The longer the accounts have been opened, the better the impact on your score.
10% of your credit score is based on the amount of debt you've accumulated in the past year.
10% of your credit score is based on your mix of credit. This would be how much unsecured debt versus secured debt you have.
So, why does this matter?
Well, your credit history feeds into your credit score. Your credit score is used by lenders to determine what they call a 'risk rating' which helps them determine your risk level and your probability of repayment. A lower score would mean a higher probability of the lender collecting whereas a higher score would indicate there is smaller risk.
This matters because lenders will assign a higher interest rate to lower score borrowers. They may not even extend credit at all. Higher rates equal higher payments which only benefit one party. Can you guess who?
Here are a few recommendations:
Visit AnnualCreditReport.com to get a free copy of your credit report from all three bureaus. You are entitled to one free report, per bureau, per year. This is the ONLY site to get a free report that doesn't require a credit card or for you to purchase credit monitoring.
Check CreditKarma for your free credit score.
Double check your report! It is not uncommon for there to incorrect information on your report. Be sure to follow up and dispute any incorrect information.