If you expect to someday apply for a loan of any type and get a competitively low interest rate, you should understand your credit report and credit score and how to improve them. A credit report is basically your credit history, while a credit score is a three-digit score based on the information in your personal credit report.
How Lenders Use Credit Reports and Scores
Most people borrow money at various times in their life, whether it’s to buy a home (or other real estate), to finance a small business, pay for educational expenses, or for other purposes. When you want to borrow money, lenders examine your credit report and your credit score(s) to determine how responsible you’ve been with credit and to help them decide whether they should lend you money (and if so, how much to charge you).
Specifically, lenders examine your history of credit usage in your credit report. This information tells the lender when each of your accounts was opened, what the recent balance is, your track record of making payments on time, and whether you’ve defaulted on any loans. A credit report also tells a prospective lender who has recently accessed your credit report and thus would indicate where else you’ve been applying for credit.
Lenders use your credit score to help them predict the likelihood that you’ll default on repaying your borrowings. The higher your credit score the better, because a high credit score means that you have a lower likelihood of defaulting on a loan. Thus, more lenders will be willing to extend you credit and charge you lower rates for that credit.
The most widely used credit score is the FICO score, which was developed by the FICO company (formerly known as Fair, Isaac and Company). FICO scores range from a low of 300 to a high of 850. Most scores fall in the 600s and 700s, and the median is around 720. You generally qualify for the best lending rates if your credit score is in the mid-700s or higher.
Obtaining Your Credit Reports and Fixing Errors
You want to get your hands on your credit report so you know what lenders are reviewing. You’re entitled to receive a free copy of your credit report (which does not contain your credit score) every 12 months from each of the three credit bureaus — Equifax, Experian, and TransUnion. If you visit www.annualcredit report.com, you can view and print copies of your credit report from each of the three credit agencies. (Alternatively, you can call 877-322-8228 and request that your reports be mailed to you.)
When you receive your reports, inspect them for possible mistakes. Credit- reporting bureaus and the creditors who report credit information to these bureaus make plenty of errors.
If your problems are fixable, there’s no need to hire someone to do so for you — you can direct getting them fixed yourself, but you will likely have to make some phone calls or write a letter or two. Some credit-report errors arise from other people’s negative information getting on your credit report.
This can happen if you have a common name, have moved a lot, or for other reasons. If the problem- atic information on your report appears not to be yours, tell that particular credit bureau and explain that you need more information because you don’t recognize the creditor.
Creditors are the source of some reporting mistakes as well. For example, perhaps a bill you paid off is still incorrectly being reported as a balance you owe. If that’s the case with your report, write or call the creditor to get the incorrect information fixed. Phoning first usually works best. (The credit bureau should be able to tell you how to reach the creditor if you don’t know how.) If necessary, follow up with a letter or an email. You can also dispute errors online directly with the credit reporting agency
Whether you speak with a credit bureau or an actual lender, make notes of your conversations. If representatives say that they can fix the problem, get their name and extension, and follow up with them if they don’t deliver the promised results. If you’re ensnared in bureaucratic red tape, escalate the situation by speaking with a department manager. By law, bureaus are required to respond to a request to fix a credit error within 30 days. And if you file a dispute and the creditor doesn’t respond, the credit bureau must then remove the derogatory item.
You and a creditor may not see eye to eye on a problem, and the creditor may refuse to budge. If that’s the case, credit bureaus are required by law to allow you to add a 100-word explanation to your credit file. Just remember that if you go this route, be factual in your write-up and steer clear of broad attacks on the creditor (such as “their customer service sucks”).
Avoid “credit repair” firms that claim to be able to fix your credit report problems. In the worst cases I’ve seen, these firms charge outrageous amounts of money and don’t come close to fulfilling their marketing hype. If you have legitimate glitches on your credit report, credit-repair firms can’t make the glitches disappear. As I explain earlier in this section, you can easily fix errors on your own without the charge.
Getting Your Credit Score
Many folks are disappointed to find that their credit reports lack their credit score. The reason for this is quite simple: The 2003 law mandating that the three credit agencies provide a free credit report annually to each U.S. citizen who requests a copy did not mandate that they provide the credit score. Thus, if you want to obtain your credit score, it’s generally going to cost you.
One circumstance allows you to get one of your credit scores for free, but unfortunately, you can only do so when you’re turned down for a loan. Current law allows you to obtain a free copy of the credit score a lender used in making a negative decision regarding your desired loan.
Improving Your Credit Reports and Score
Take an interest in improving your credit standing and score rather than throwing money away to buy your credit score or paying for some ongoing monitoring service to which you may not pay attention. Working to boost your credit rating is especially worthwhile if you know that your credit report contains detrimental information or if your score is lower than 740.
Here are the most important actions that you can take to boost your attractiveness to lenders.
Check Your Credit Reports for Accuracy
Correct any errors, and be especially sure to get accounts removed if they aren’t yours and they show late payments or are in collection. Refer to the earlier section “Obtaining your credit reports and fixing errors” for more information.
Pay All Your Bills on Time
To ensure on-time payments, sign up for automatic bill payment, which most companies encourage customers to use. This enables companies to automatically deduct (typically monthly) what you owe
from your checking account or to charge that amount to your credit card so you don’t have to remember to pay the bill. (This also prevents you from being charged interest or late fees when you make a payment after the due date.)
Be Loyal If It Doesn’t Cost You
The older the age of loan accounts you have open, the better for your credit rating. Closing old accounts and opening a bunch of new ones generally lowers your credit score, so don’t jump at a new credit-card offer unless it’s really going to save you money, such as if you’re carrying credit-card debt at a high interest rate and want to transfer that balance to a lower-rate card (or provide you with rewards/benefits greatly in excess of any costs). Ask your current credit-card provider to match a lower rate you find elsewhere.
Limit Your Total Debt and Number of Debt Accounts
The more loans, especially consumer loans (credit cards, auto loans, and so on), that you hold and the higher the balances, the lower your credit score will be. Work to pay down consumer revolving debt, such as on an auto loan and credit cards.
Many thanks to Wiley for granting us permission to publish this excerpt. If you’re interested in reading an excerpt from another book of Eric Tyson’s, check out “Making Sense of Your Investing Options,” on our sibling blog Thousandaire. Or read “Common Financial Mistakes Young People Make” on another of sibling blogs, Saving Advice.
Readers, how are you faring with your own credit scores?