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CREDIT REPORTS AND CREDIT SCORING
Credit Scores Credit Bureau Scores were developed in the 1980’s to help banks and financial institutions make quick, non-biased decisions and has quickly spread to the mortgage and auto related industries. A Credit Bureau Score is a snapshot of the consumer’s credit profile at a certain point in time and summarizes in a number, the risk potential or likelihood that an individual will pay back a loan. The score is based solely on the data within a consumer’s credit file and does not use demographic information such as race, color, religion, national origin, gender, age, or marital status. The most widely used Credit Bureau Scores are “FICO”SM or Fair, Isaac scores. FICO scores can range from the 300’s to the mid 800’s and the higher the score the better credit quality or lower risk. These scores are available from each of the three national credit repositories and each has its own name.
Equifax scores are called BEACONTM scores* Experian scores are called EXPERIAN/FAIR ISAAC scores Trans Union scores are called EMPERICATM scores**
These scores are calculated by a system of scorecards. These scorecards were developed using thousands of consumers’ actual credit reports and applying complex mathematical equations that would evaluate and compare patterns of payments. Weights and measures were assigned to the variables involved and statistical models were created. The types of credit information variables used in these scorecards usually consists of payment history, amounts owed, length of credit history, new credit, and types of credit in use. Scores are dynamic, meaning they change all the time. Each time a credit report is ordered, the credit profile goes through the scoring process. This allows consumers to be matched with other consumers with similar credit histories. It would not be fair to compare a person with just a few years of credit experience to someone with many years of credit experience. Because of this process, variables can differ from scorecard to scorecard. (Inquiries on one consumer with few years of credit history may not count as much as inquiries on a consumer with many years of established credit.) For a score to be calculated on a credit report, the consumer must have at least one account that has been opened for six months or longer and has had activity within that six month time frame.
Calculations of credit scores are derived from the following factors: A) Approximately 35% of scores are based on the subject’s payment history. A good payment history will certainly help the score. The overall number of derogatory tradelines will also effect the score. Recent delinquencies or items appearing in public records have a major impact on credit scores. If delinquencies or items appearing in the public records are in the distant past, the impact on credit scores will be less than if they are more recently reported. B) Amounts owed count for approximately 30% of scores. The number of accounts with balances, the balances compared with the available credit limit, and the overall amount owed on all accounts are the factors falling into this category. C) The length of credit history accounts for approximately 15% of credit scores. How long credit had been established and recent activity on accounts is what is important. The way to avoid damaging credit with respect to credit histories is to avoid opening too many accounts in a short period of time. D) New credit counts for approximately 10% of credit scores, and types of credit in use count for approximately 10%. How many new accounts and how long since new accounts have been established is key. Re-establishing new credit since having past payment problems will help the score. The number of recent credit related inquiries might have an adverse effect on the score. Shopping for too many accounts may be looked upon asbeing risky. An inquiry to obtain a copy of a credit report from a credit reporting agency does not count toward the score. All mortgage and auto loan inquiries within a 14-day time frame only count as one inquiry and do not count toward a consumer’s score within 30 days from the date a credit report is drawn. To help lenders understand the score, up to four factor reason codes come with each report. There are approximately 60 possible reason factor codes. Here are a few examples: code #10-proportion of balances to credit limits is too high on revolving accounts code #14- length of time accounts have been established code#22- serious delinquency, derogatory public record, or collection filed These reason codes shown on the report tell the most important factors in determining the credit score. In the mortgage industry, it is normal for a lender to order a credit report that merges information from all three repositories and displays all three scores. This allows the lender to see the entire picture of the consumer’s credit worthiness. Often the rule for the lender is to use the middle of three scores when three are given, or the lower of two scores if only two bureaus are accessed. Fair Isaac states that, based on the FICO scores of the general population of the United States, 20% score below 620, 20% between 620 and 690, 20% between 690 and 740, 20% between 740 and 780, and 20% over 780.
Credit ReportsA credit report details financial obligations an individual has with banks, retailers, credit unions, mortgage companies, and financial institutions. Typically found in a credit report is information regarding the creditor, account numbers, open dates of the accounts, types of accounts, terms, amount of credit or loan, payment amounts, balances and any amounts past due. These accounts, including accounts that have been closed or paid off, usually remain on a credit record for seven years. A revolving credit arrangement can remain on the record for an infinite period of time as long as it is being used. This information is supplied to the three national repositories, Equifax, Experian, and Trans Union on a monthly basis via magnetic tape. The tapes report on open, paid, current and past due accounts that creditors have in their database. The three repositories sell the credit reports to other credit grantors so they can check payment histories and credit scores and decide whether or not to grant credit. Public Records information including bankruptcies, tax liens, and judgments is also included in the report and is usually supplied directly from the Public Records of local Court Houses. Public Records information usually remains on credit records for a period of seven years with the exception of bankruptcies, which remain on the record for a period of ten years, and open tax liens, which can remain for fifteen years. Credit reports show in detail inquiries that have been made in the last two years. These inquiries usually display the lender or credit grantor, the date, and in some cases, the type of credit requested. Information about a consumer’s credit profile can differ from repository to repository. For instance, a local bank, retailer or credit union may elect to report to only one repository to save on the costs associated with reporting to all three. The same account may be reported differently to each of the three repositories because of delays in getting the automated tape to a specific repository in time. (Example: one repository shows the account as current, the second shows the account as current but with the notation that it was thirty days past due at one time, and the third shows that the account is currently thirty days delinquent.) Even though it is the same account, it could be reported three different ways. Family members with the same name sometimes have their files mixed with other family members with the same name. They may both live at the same residence, but even with different social security numbers and birth dates it is still possible for the bureaus to mix up the accounts. Sometimes human errors can happen and data is input incorrectly. A payment could be posted incorrectly or be applied to an incorrect account number. For these reasons, it is recommended that every consumer get a copy of his or her credit report at least once a year from each repository. All three repositories have web sites where reports can be requested for a nominal fee, usually $8. An exception to this is made for a person who is denied credit, in which case a copy of the credit report should be provided for free. These reports can be ordered directly from the repositories through a simple Internet search. Consumers have the right to challenge any inaccuracies reported. The procedure for this is to notify the repository of the dispute on the accounts to be challenged. The repository will send out a dispute form on behalf of the client to the creditor(s) named. The creditor(s) then has thirty days (twenty business days) to respond to the dispute. Should a response not be returned within this time period, the subject has the right to request that the item be changed to the status requested. If a response comes back, but the consumer still disagrees with the result, they have the right to enter a consumer statement of up to 100 words on the credit report explaining the dispute.
In the middle of the twentieth century, using credit was a sign of weakness. People were taught to save and pay cash for everything. Asking for credit, except perhaps in the instances of purchasing a home or automobile, meant that a person did not save enough cash to pay for purchases. Times have changed! Now, credit is used for every purpose imaginable. Establishing credit can be as easy as going to a bank and sitting down with the manager to discuss credit needs. Most banks can issue their own credit cards and will be willing to extend limited lines until credit is established. It can begin small with a limit of $300, and then grow to $500. It is often best to meet face to face with a manager or credit officer as opposed to simply making an application for credit. This may help expedite the approval process and give the applicant an opportunity to explain any potential credit issues and have his intent be better understood. From the initial time credit is established the best way to proceed to building credit is to borrow or charge a small amount and pay it back immediately. Then repeat this process perhaps even increasing the amount of the borrowings. The important thing to remember is to continually pay all amounts owed when they become due, to never miss a due date, and preferably pay off all amounts when due as opposed to making minimum allowable payments. Once credit has been established, the idea is to maintain it, and the only way to maintain credit is to repay it according to the terms outlined in the credit agreement. *BEACON is a registered trademark of Equifax **EMPERICA is a registered trademark of Trans Union FICO is a service mark of Fair Isaac and company
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