How a Credit Reporting System Works

Origins

Though the credit reporting system has been a vital part of consumer lending for decades, the same system used by banks to determine financial health and consumer risk is also used by many other entities. Prospective employers use credit reporting systems to determine the financial health of applicants who are seeking employment with their companies, and many landlord run credit checks to determine whether or not a potential tenant is an acceptable risk. Regardless of how these credit reporting systems are used, the fact remains that they are an important part of the decision-making process for many industries. However, many people aren't aware of exactly how they work or how to best use the system to their advantage.

How Credit Reports Work

Credit bureaus get their information from a variety of sources. Local and regional credit reporting services are typically used as sources for the main credit reporting agencies, which include Equifax, TransUnion and Experian. Companies with whom a consumer does business, including credit card companies, banks with whom the consumer has outstanding loans, and even utility companies provide account information to the credit reporting agency. Outstanding balances and past-due amounts are the primary pieces of information reported to the credit reporting agency, though other pieces of information--including student loan amounts and public court judgments--are available through the credit reporting agency as well. Each time a consumer goes looking for a loan, the company from which the loan is sought consults the credit bureaus. The credit bureau shares this information with the company, and the company bases its decision, in large part, on the data provided. A consumer's entire past credit history, including any late payments or foreclosures, is included in the report. Prospective lenders take a number of factors into account, including credit lines that have reached their limits and the debt-to-income ratio of the person who is seeking the loan. However, even though credit reporting agencies wield immense power in the financial industry, they are subject to heavy regulation by the government.

Legal Requirements

The entire credit reporting system is subject to the Fair Credit Reporting Act. The Act specifies precisely how these agencies can do their business, and how they must treat the information that they hold. Only companies with whom a consumer does direct business can access a credit report, and potential employers can only do so with express written permission from the job applicant. Though credit reporting agencies can provide consumer information to telemarketing firms, they must not do so if consumers request that they be excluded from any such lists. Credit reporting agencies must provide at least one free credit report annually to each consumer, and credit reporting agencies are required by law to investigate any claims of inaccurate information that are lodged by the consumer.