A discussion about debt wouldn’t be complete without talking about credit reports and credit scores. Don’t overlook this important financial planning task. Even if you don’t think that you will need credit extended to you in the near future, it’s still important to check your credit report and credit scores as they are used for more than just obtaining credit.
When we arrived back to the United States from our four-year international assignment in Asia, we were looking to purchase a new home and requested a pre-approval for our new home mortgage loan. Unfortunately, my credit score came back in the mid 600’s despite having an excellent credit history my entire life. After a look at my credit report, I discovered that I had $15 in collections from a utility company during a time that we were renting out our home while we were away. I had never seen a bill for this, let alone been contacted by anyone about the delinquency. This tiny amount in collections dropped my credit score well over 100 points. I was able to fairly quickly resolve the problem by paying the bill immediately and calling the utility company to remove the item from my credit history with an explanation of the situation, but I definitely should have kept a better look at my credit report on an ongoing basis to avoid this stress at an already stressful time.
This information is important for everyone! Let’s go through some basic questions about credit reports and credit scores.
WHAT IS A CREDIT REPORT?
Your credit report is a record listing your personal debt history, including loans you’ve taken out within the past 7 years and the details regarding how much you’ve paid back, whether you’ve made your payments on time, and other loan terms. It also includes any bankruptcies or credit defaults you have on record.
In the U.S., there are three credit bureaus that report this information:
- Equifax, and
Each credit bureau may have slightly different information on file. In my case where the utility company reported a delinquency, it was only listed on my Experian credit report but it did impact my overall FICO credit score.
WHAT DOES YOUR CREDIT REPORT INCLUDE?
- Personal Information – Your name, date of birth, social security number, current and previous addresses, telephone number and employment information
- Loan Account Information – Each account is listed with the date opened, account & loan type, payments made and a rating on the status the payment (current, late, etc.), the terms of the loan and date the account was closed, if applicable. This is where accounts will be specifically marked if there are any repossessions, foreclosures or accounts in collection.
- Credit Inquiries – There are two groups of inquiries listed on your credit report: promotional inquiries and account review inquiries. Promotional inquires are from companies that want to market credit and do not affect your credit score. Account review inquires are from companies that you currently have an account with or that you have applied for credit with. Many of these latter inquiries have an impact on your credit score, as too many inquiries in a short period of time may mean that you may be in financial trouble and need credit to support your living expenses.
- Credit Report Messages – There is a section at the bottom of your credit report with messages (mine includes a message that I have opted out of being on promotional lists for that credit bureau).
WHO CHECKS YOUR CREDIT REPORT?
There are some very obvious, but also some less obvious times when your credit is checked:
- When you apply for revolving and non-revolving credit and loans of any kind (credit cards, mortgages, auto loans, student loans, etc.)
- When you apply for insurance at a new institution (in most states)
- When you sign up for a new cell phone contract or finance your cell phone as part of the deal
- When you apply for a new job (in certain states and certain occupations)
- When you apply for a loan to start a small business
- When you submit an application to rent an apartment or home
- When you get your utilities hooked up by utility companies (if you have bad credit, they will require you to pay a deposit-yes, this happened to me due to the previous situation I mentioned)
HOW DO YOU CHECK YOUR CREDIT REPORT?
You can get all 3 of your credit reports by visiting AnnualCreditReport.com. This website will walk you through the process and you will have to provide detailed personal information, including your social security number. U.S. federal law requires that you can check your credit report free of charge from each credit bureau every 12 months. You can choose to either check them all at one time or spread them out throughout the year.
You should be very wary of other sites that want you to pay monthly subscription fees for monitoring your credit. In most cases, these tend to be a total waste of money and do not provide you with enough value. The credit bureaus make money by offering these services, but they are not at all necessary for the vast majority of people.
WHAT SHOULD YOU BE CHECKING FOR ON YOUR OWN CREDIT REPORT?
After you download your credit reports, you should be checking the following information:
- Accuracy of personal information provided (name, addresses, employment information)
- Accuracy of records for both open and closed loans (check recently opened loans to make sure your identity has not been stolen)
- Any late payments or delinquencies listed for any accounts
- Names of institutions that have requested a full copy of your credit report recently (this will also help you identify identity theft)
WHAT DO YOU DO IF YOU FIND ERRORS ON YOUR CREDIT REPORT?
The first step if you find errors on your credit report is to contact the company that reported the information directly. You should simultaneously contact the credit bureau(s) that have the mistake by following the instructions listed directly on your credit report. They will require you to send a dispute letter via registered, return receipt requested mail so that you can prove the receipt of the letter. In most cases, this isn’t a very quick process, which is why it is highly recommended that you check your credit reports sufficiently in advance of when you are considering taking out a new loan.
WHAT IS YOUR CREDIT SCORE AND HOW DOES IT RELATE TO YOUR CREDIT REPORT?
Your credit score is essentially your “grade” at using credit and debt wisely and responsibly. It is calculated based on the information from your credit report. The FICO score is the most common and the only one I’ll mention here. FICO credit scores range from 350-850. Lenders classify them into the following rough categories:
- 720-850: Excellent credit
- 660-719: Good credit
- 600-659: Fair credit
- 350-599: Bad credit
The formula for calculating credit scores isn’t publicized, but we know it’s made up of the following:
- 35% Payment history – do you always make your payments and always make them on time?
- 30% Amounts owed – how much do you owe compared to the maximum amount you are allowed to borrow?
- 15% Length of credit history – how long have you had your credit cards and loans?
- 10% Credit mix – do you mostly have credit cards or also other long-term credit such as a mortgage or student loan?
- 10% New credit – how much “new” credit have you recently applied for and received?
HOW DO YOU GET YOUR CREDIT SCORE?
For some reason, getting your actual credit score is more difficult than getting your credit reports. If your credit reports show a credit history with different types of accounts, no delinquencies or late payments and accounts that aren’t maxed out you likely have a fairly decent credit score, however if you are planning to take out a mortgage or larger loan in the near future, you will want to check your credit score.
These days, there are quite a few credit cards that offer your credit score for free. We have a Citi Dividend credit card that provides an updated FICO score quarterly. Other than Citi, many other credit card companies offer a free FICO score on all or some of their cards. It’s definitely worth it to check your credit card first to see if you can get this information online or on your monthly statement.
If your credit card doesn’t offer your FICO score, a free option would be to use CreditKarma, which estimates your credit score but doesn’t pull the actual score. If you want your exact score, you will have to pay for the information at myFico.com. Be sure you are selecting to get your one-time score and not the outrageously expensive monthly subscription. It should also be sufficient to purchase only one FICO score from the credit bureau that has the most information from you (or the most negative information) regarding your loans.
WHY DOES YOUR CREDIT SCORE MATTER?
Having a high credit score can help you to get a loan, obtain lower interest rates, lower insurance premiums and can save you thousands of dollars over the lifetime of your loans.
Having a high credit score can also be essential when you’re applying for jobs, especially in the accounting and financial management fields. If you’re not responsible with your own money, how can you be expected to be responsible with other’s money?
While there are arguments that building credit isn’t necessary and that loans can be manually underwritten to substitute for a good credit score, research shows that it is most ideal to show lenders that you have had credit in the past and used it responsibly so that they will want to extend credit to you at lower interest rates. Learning to use credit responsibly is more beneficial than avoiding credit altogether, but it is certainly better to have no credit score than a low credit score!
If you have additional questions, do your research and be prepared about how to build your credit and monitor your credit reports and scores.