In ads on TV, radio and the Internet and in newspapers, you hear and see announcements about credit reports and scores. It has become so constant that borrowers are getting the message that to buy and finance anything, they need to check their credit report and scores. You can check your credit report once per year for free by going to annualcreditreport.com. (see Resources). You can access your scores for a small charge. These are not one in the same, since scores are a result of what is in your credit report, but getting approved for new credit is largely dependent on your scores.
What's in Your Credit Report
Your credit report is a compilation of all of your accounts which you are making and have made payments on. These are consumer credit accounts such as credit cards, auto loans, bank loans and your mortgage. It will contain payment histories and will include late payments as far back as seven years, and will show any collections. Your credit report will show your home (or mailing) address, and where you work. It will have a public records area showing any judgments, liens and bankruptcies. Your reports are updated each time a creditor reports new or updated credit information.
What a Credit Score Is
Credit scores are created as a direct result of the information in your credit report. Scores have become important, since all lenders use credit scores to determine probability that you will default on a financial obligation. The higher the scores, the less likelihood of default. The information and balances in your credit report are assessed by a scoring model (software), which uses math algorithms to determine your scores. The Fair Isaac Corp. first created credit scores, thus you hear them referred to as FICO scores.
What Determines Your Score
Fair Isaac Corp. says credit scores are made up of five components:
1. Your payment history makes up 35 percent of your scores, which explains why a late payment is so devastating to your scores.
2. The amount of money you owe makes up 30 percent of your scores. Credit cards that sit near their maximum limit injure scores.
3. The length of your credit history makes up 15 percent of your scores. Keep and maintain older accounts such as credit cards.
4. The type of credit you use makes up 10 percent of your scores. Having a mix of types of accounts will help your scores rather than having several credit card accounts.
5. New credit makes up the last 10 percent of your scores. This covers inquiries and new accounts that have resulted from the inquiry, and type of credit recently established.
What Hurts Your Score
The biggest hit to credit scores is found in the reporting of late payments. You will be affected by this for up to a year, but the more time that passes, the less impact it will have as long as there are no more late payments. Pay all bills on time or early. The next big negative hit to scores is having high balances on loans, especially credit cards. Pay them down to 40 percent or less of the maximum credit line. The next biggest hit is the age of your accounts. New credit will not have the seasoned (aged) payment history of an old, well-maintained account. If you close out accounts, do not close out all of your old ones: the older ones are worth more to your score. If you are building credit, having a mix of types of credit will help scores more than having all of the same type of account (such as credit card accounts). If your report shows several inquiries, there may be a new account as a result. Any new credit will affect your scores until it is old enough to have a payment history. This usually takes about six months.
Your Rights
Because of the Fair Credit Reporting Act, the borrower has the opportunity (and is encouraged) to get his credit reports (and scores) before applying for credit, allowing him to dispute any accounts or information that he believes to be inaccurate, duplicated or outdated. This gives the borrower a proactive way to stay on top of what is being reported and improve his scores. The credit reporting agencies (CRA) must correct or delete inaccurate information. These reports must be given to a consumer free of cost once per year. Consumers have the right to view their credit scores as well, but there is a small cost for each of the three scores. Under this act, the consumer must be informed if any information in his file has been used against him. If he applied for credit and was turned down, he can send the denial letter to the bureaus and they must give him an updated report. Since credit reports contain private information, access must be limited to those who have a need, such as a bank where you have applied for credit or a landlord from whom you are trying to lease a property. Under any circumstances where credit is being pulled, the consumer's written permission is usually required.
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