Frequently Asked Questions

 

What's a credit score?

A credit score is a number that attempts to predict your “credit-worthiness” at any given moment. Officially, it’s supposed to predict how likely you are to become at least 90 days late on payments within the next twenty-four months. Credit scores are calculated using complex, secret formulas that are only known by the companies that produce them (although these companies have given us some general guidance on how they calculate credit scores.)

A company called Fair Isaac Corporation pioneered the use of credit scores in 1956, but they didn’t become widely used by creditors until the 1980’s. Then, in 1995, Fannie Mae and Freddie Mac recommended the use of credit scores in mortgage lending. From then on, credit scores became perhaps the single-most important tool for creditors when offering loans to consumers.

Now, credit scores are even used by insurance companies and other service providers in determining whether, and on what terms, they will offer their services to you. (Personally, we have real problems with the use of credit scores in the granting of insurance and other services. We have difficulty believing that someone doesn’t deserve home or car insurance because they got sick and fell behind on their bills. Unfortunately, we don’t get to set the rules. So, we just have to do everything we can to improve your credit scores so that you don’t have problems with anyone - creditors or service providers!)

There are now many different types of credit scores, developed by different companies, for use in different industries. For example, there are credit scores that are used solely for automotive lenders, credit card issuers, or finance companies. (Some commentators have suggested that, between the different credit scoring companies, there are more than 1000 different credit scoring models currently in use.) But, the most widely used credit score, by far, is the score developed by the Fair Isaac Company, the pioneer of credit scores.

The credit score developed by Fair Isaac is known as a “FICO” score (from the “Fair Isaac Corporation”). To determine a FICO score for a consumer, Fair Isaac developed a formula based on nearly forty different “characteristics” that it claims predict the likelihood that the consumer will repay their debts.

Fair Isaac also groups different classes of consumers according to key “attributes” and then compares a given consumer’s credit file to other consumers in that same group. For example, there may be a group of consumers who have filed for bankruptcy. There may be another group of consumers who have one late payment, and so on. Fair Isaac believes that separating consumers into groups of consumers with common key attributes makes the credit score even more predictive of credit worthiness. This system is called a “scorecard” system.

But guess what? There’s more than one credit scoring model. Sure, there are other companies that have their own credit scoring system (we’ll talk about that in a minute). But, even Fair Isaac has more than one credit scoring model. In fact, they have many different credit scoring models.

The most commonly used model is known as the “Classic” FICO scoring model. This model uses 10 “scorecards” or groups of people with similar key attributes. But, Fair Isaac has also developed another scoring model called “Next Generation” or “NextGen” that uses 18 scorecards or groups. Fair Isaac believes that the NextGen scoring model is even more advanced and predictive than the Classic model. In addition, Fair Isaac has developed enhancements to the Classic model.

So, why should you care about this? Well, it’s a problem for us every day, because different creditors use different credit scoring models. Some may use the Classic FICO. Others may use the enhanced versions of the Classic FICO. Still others may use the NextGen FICO. And the result? Yes, that’s right, different scores.

We may pull a credit score for a potential borrower, and get one score. But, if a lender uses a different credit reporting company for their credit report, it’s very possible that the credit score will be different. So, while the borrower would qualify for a certain loan based on our credit report and score, the borrower may NOT qualify using the lender’s credit report. This can be a real problem for loans that are teetering on the edge anyway. (Some lenders, recognizing this problem, are allowing mortgage brokers to use the credit report and score from “their” credit provider, and will qualify the borrower based on that credit report.)

How are credit scores calculated?

Fair Isaac and Vantage Score hold their credit scoring formulas as a close secret much like the formula for Coca-Cola or your grandma’s legendary double chocolate-chip cookies. This can be very frustrating for consumers when they see remarks on the credit report like “too many revolving debt accounts” and not knowing exactly that means.

Fortunately, Fair Isaac and Vantage Score have issued some public information about how they calculate credit scores. Let’s take a look at the various factors:

The five categories that determine your score, in order of importance, are:

35% Payment History

30% Amounts Owed

15% Length of Credit History

10% New Credit- (Average Age of Accounts)

10% Types of Credit (Mix Of Credit, Credit Cards, Installment Accts, Mortgage)

Payment History:

The top rated factor for both models is payment history. This is because lenders want to know a person’s payment history--past and present. This category can be broken down into three subcategories:

• Recency – This is the last time a payment was late. The more time that passes the better.

• Frequency – One late payment looks a heck of a lot better than a dozen.

• Severity – The “Hierarchy of madness” so to speak, rest on the logic that a payment 30 days late is not as serious as a payment 60 or 120-days late. Collections, tax liens and bankruptcies are credit score killers.

How much is owed:

The score looks at the total amount owed on all accounts as well as how much you owe on different types of accounts (mortgage, auto, etc). Using a higher percentage of the credit limits will worry lenders and hurt the credit score. People who max out their limits have a much greater risk of default.

Utilization:

When it comes to revolving debt-credit cards, the formula looks at the difference between the high limit and balances. For Example, let’s say your customer has a MasterCard with a credit limit of $10,000 and they have spent $2,000 of it. This is a 20% utilization ratio. The lower the ratio, the higher the credit score. So, if your client’s are looking for a quick credit score boost, have them pay down any accounts they can. Don’t expect this to be instantaneous as it can take up to 45 days for the credit bureaus to update reports.

One more important tidbit, CLOSED ACCOUNTS do not help and can hurt if there is a balance remaining. Therefore, tell clients not to close accounts.

Length of credit history / Depth of credit:

This is less important than the previous factors, but it still matters. It considers (1) the age of the oldest account and (2) the average age of all your accounts. It is possible to have a good score with a short history, but typically the longer the better. Young people, students, and others can still have high credit scores as long as the other factors are positive. If a person is new to credit then there is little they can do to improve a credit score. The only solution is to open an account and be patient.

New Credit / Recent Credit:

New credit is not always a bad thing. However, opening new accounts can hurt a credit score, particularly if a consumer applies for lots of credit in a short time and doesn’t have a long credit history. The score factors in the following:

• How many accounts the consumer applied for recently

• How many new accounts the consumer has opened

• How much time has passed since the consumer applied for credit

• How much time has passed since the consumer opened an account

The model looks for “rate shopping.” Shopping for a mortgage or an auto loan may cause multiple lenders to request your credit report many times each, even though a person is only looking for one loan. Auto dealers are notorious for running 3 to15 credit reports. This is called shot gunning the credit. Luckily, to compensate for this, the score counts multiple inquiries in any 14-day period as just one inquiry.

For most people, a credit inquiry will take less than five points off their score. However, inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk. According to MyFico.com, people with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports.

Types of credit you use / depth of credit:

Both models want to see a healthy mix of credit, but they are vague on what this means. They recommend you have a balance of both revolving debts like credit cards and installment loans like auto loans or a mortgage.

What is a “FICO” score?

Different FICO credit scores are just the beginning. Adding to the confusion are “educational” credit scores that Experian and Trans Union offer to consumers through their web sites and through hundreds of affiliated companies.

If you’ve visited the web site for Experian or Trans Union, you probably found it hard to JUST order your credit report. On both sites, it takes some real investigative work to figure out how you can avoid ordering a credit score or credit monitoring service with your credit report.

But, you’re probably asking, is that a bad thing? After all, we said that credit scores are more important than credit reports, right? Well, yes, that’s true. But, you need the RIGHT credit scores. And the credit scores that Experian and Trans Union are pushing on their web sites are NOT the credit scores that they provide to third parties.

Experian's PLUS Score

On thier web site, Experian offers the “PLUS Score.” The PLUS Score is a proprietary score developed by Experian, and featured prominently in its web site. You really have to dig in the Experian web site to find out that the PLUS score is really an “educational” score. In its web site, Experian says that “the PLUS score is derived from information based on a credit report, using a similar formula to those used by lenders.” Did you get that? The PLUS Score is a “similar” formula to those used by lenders. So, bottom line, it’s NOT the score that lenders use.

It’s supposed to be “easier to understand” than other credit scores (the FICO scores) and allows consumers to “see how changes to their credit habits can directly influence their credit rating.” So again, it’s not the score that creditors use in granting you credit. It’s an educational tool to allow you to see how changes to your credit “habits” can affect your credit score. So, for “educational” purposes, the PLUS Score is OK.

Trans Union's TrueCredit Score

Like Experian, Trans Union has its own proprietary credit score that it offers on its web site – the TrueCredit score. And, like the PLUS Score, you have to dig deep to find an explanation that the TrueCredit score is not a FICO score. In its web site, Trans Union says “TrueCredit is not connected in any way with Fair, Isaac and Company; the credit score provided here is not a so-called FICO score. The credit scores of TransUnion may not be identical in every respect to any consumer credit scores produced by any other company.” So, the TrueCredit score is another “educational” score that is NOT used by creditors in evaluating you for credit.

So What's the Problem with the PLUS Score and the TrueCredit Score?

What’s wrong with looking at the PLUS Score and the TrueCredit score? After all, they’re educational, right? Well, yes, but…. If you want to spend your money, then go ahead. But, if you really want to see the scores that your lenders are going to see, then you need to stick with the FICO scores.

Your lender will never see your PLUS Score or your TrueCredit score. And, in our experience, these scores are almost always considerably higher than the FICO scores based on the Experian and TransUnion credit information – the Experian/Fair Isaac and the FICO Risk Score, Classic. We’ve seen differences of more than 50 points between these “educational” credit scores and the FICO scores.

(This usually comes up when a borrower starts complaining that the scores they got online were much higher than the scores received by a mortgage broker who pulled their credit. They usually think that the mortgage broker is trying to trick them in order to justify a higher rate. Although we have no doubt that this happens, generally the difference in scores is really the difference between the FICO scores and the educational scores.)

So, bottom line – make sure that you review and work on improving your FICO scores. It MAY help to pull the PLUS Score and TrueCredit Score and play with the simulators that Trans Union and Experian offer with these scores. But, to REALLY improve the credit scores that your lenders will use, you need to understand the FICO scoring system.

What is a credit report?

You are the source of great interest, and profit, of many national companies. These companies, known as “consumer reporting agencies” under the Fair Credit Reporting Act, gather financial and other information about you and millions of other consumers across the country. They use this information to make a profit – that’s right, they sell your information to make a buck.

The FCRA defines a consumer reporting agency as:

Any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating customer credit information or other information on consumers for the purpose of furnishing consumer reports to third parties, and which uses any means or facility of interstate commerce for the purpose of preparing or furnishing consumer reports.

These consumer reporting agencies sell your information to businesses and individuals with a “legitimate” need to know something about you. Most often, these businesses are creditors that want to lend you money or otherwise provide you with credit. But, the consumer reporting agencies have many customers that are eager for your information, including prospective employers, landlords, and insurance companies – see the box.

All of these businesses and individuals are trying to decide whether you’re a “good risk” for whatever it is they’re offering to you. If your credit report contains mostly “good” information, then you’ll probably receive the loan or service. But, if your credit report contains mostly “bad” information, then you’re probably not going to get the loan or service.

We’re going to closely examine the information that’s contained in your credit reports in a moment, and then we’re going to talk about how to fix that information – because we guarantee that some of it is wrong. But for now, let’s take a close look at the major consumer reporting agencies.

(As with the term “credit report,” the term “credit bureau” never appears in the FCRA. All of the companies that we typically think of and call “credit bureaus” are in fact consumer reporting agencies. As with the term “credit report,” a “credit bureau” is really a sub-set of consumer reporting agencies that primarily collect, maintain, and sell credit information to third parties, as opposed to information regarding medical or insurance claim histories, for example. For our purposes, we’ll refer to the major consumer reporting agencies as “credit bureaus,” because that is the generally accepted term for them.)

The Big 3

There are currently three major credit bureaus (consumer reporting agencies) that collect, maintain and report general credit information regarding consumers– Equifax, based in Atlanta, Georgia; Experian (formerly TRW) based in Costa Mesa, California; and, TransUnion, based in Chicago, Illinois. These companies now each maintain credit information on more than 200 million consumers nationwide.

Specialized Credit Bureaus

In addition to the Big 3 Credit Bureaus, there are many other consumer reporting agencies that supply “specialized” consumer information to interested businesses and individuals. The FCRA calls a company that collects and maintains specialty information a “nationwide specialty consumer reporting agency.” These companies collect and maintain information relating to (1) medical records or payments (Medical Information Bureau “MIB”); (2) residential or tenant history (ChoicePoint, SafeRent, UD Registry); (3) check writing history (ChexSystems, Shared Check Authorization Network “SCAN”, and TeleCheck); (4) employment history (ChoicePoint); and (5) insurance claims (ChoicePoint and ISO Insurance Services).

These nationwide specialty consumer reporting agencies CAN have a major impact on our life. Fortunately, they fall within the restrictions of the FCRA. This means that you can see the information these companies have about you, and you’re entitled to one free report each year.

What’s a credit bureau?

Consumer Reporting Agencies - We Call Them "Credit Bureaus"

You are the source of great interest, and profit, of many national companies. These companies, known as “consumer reporting agencies” under the Fair Credit Reporting Act, gather financial and other information about you and millions of other consumers across the country. They use this information to make a profit – that’s right, they sell your information to make a buck.

The FCRA defines a consumer reporting agency as:

Any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating customer credit information or other information on consumers for the purpose of furnishing consumer reports to third parties, and which uses any means or facility of interstate commerce for the purpose of preparing or furnishing consumer reports.

These consumer reporting agencies sell your information to businesses and individuals with a “legitimate” need to know something about you. Most often, these businesses are creditors that want to lend you money or otherwise provide you with credit. But, the consumer reporting agencies have many customers that are eager for your information, including prospective employers, landlords, and insurance companies – see the box.

All of these businesses and individuals are trying to decide whether you’re a “good risk” for whatever it is they’re offering to you. If your credit report contains mostly “good” information, then you’ll probably receive the loan or service. But, if you’re credit report contains mostly “bad” information, then you’re probably not going to get the loan or service.

We’re going to closely examine the information that’s contained in your credit reports in a moment, and then we’re going to talk about how to fix that information – because we guarantee that some of it is wrong. But for now, let’s take a close look at the major consumer reporting agencies.

(As with the term “credit report,” the term “credit bureau” never appears in the FCRA. All of the companies that we typically think of and call “credit bureaus” are in fact consumer reporting agencies. As with the term “credit report,” a “credit bureau” is really a sub-set of consumer reporting agencies that primarily collect, maintain, and sell credit information to third parties, as opposed to information regarding medical or insurance claim histories, for example. For our purposes, we’ll refer to the major consumer reporting agencies as “credit bureaus,” because that is the generally accepted term for them.)

The Big 3

There are currently three major credit bureaus (consumer reporting agencies) that collect, maintain and report general credit information regarding consumers– Equifax, based in Atlanta, Georgina; Experian (formerly TRW) based in Costa Mesa, California; and, Trans Union, based in Chicago, Illinois. These companies now each maintain credit information on more than 200 million consumers nation-wide.

Specialized Credit Bureaus

In addition to the Big 3 Credit Bureaus, there are many other consumer reporting agencies that supply “specialized” consumer information to interested businesses and individuals. The FCRA calls a company that collects and maintains specialty information a “nationwide specialty consumer reporting agency.” These companies collect and maintain information relating to (1) medical records or payments; [Medical Information Bureau “MIB”] (2) residential or tenant history [ChoicePoint, SafeRent, UD Registry]; (3) check writing history; [ChexSystems, Shared Check Authorization Network “SCAN”, and TeleCheck] (4) employment history; [ChoicePoint] and (5) insurance claims [ChoicePoint and ISO Insurance Services].

These nationwide specialty consumer reporting agencies CAN have a major impact on our life. Fortunately, they fall within the restrictions of the FCRA. This means that you can see the information these companies have about you, and you’re entitled to one free report each year.

What's included in your credit report?

Accounts/Trade lines:

This includes credit cards, auto loans, mortgages, real estate, installment loans and revolving debt like department store cards. The report will include information on the accounts such as the balance, payment history, terms, and account status such as whether the account was put into bankruptcy, charged off, or repossessed.

Collection Accounts:

Collections are accounts that are seriously past due and have been transferred to a collection agency or creditor's internal collection department. Collections can appear to be paid and unpaid (and, yes this makes a difference when disputing…more on this later). Any type of collection whether it is paid or unpaid it is negative.

One thing you may encounter is multiple listings on credit reports for the same debt. This happens as the debt collection agencies sell the debt to other agencies. As debt is transferred between different agencies, there may be several records on the credit report for the same debt. Only one record should be marked as open at a time on the credit report.

Public Records:

The public information section of the credit report includes publicly available information about legal matters affecting your client’s credit. This could include judgments in civil actions, state or federal tax liens and bankruptcies. All court records, including satisfactions, are considered negative by all credit grantors. Because some public record information is accessible only by visiting courthouses and other government buildings in person, the credit bureaus have to send people to the courthouse to gather the records.

Inquiries:

Every time credit is applied for, a credit report is pulled. The inquiry section of a credit report includes records of businesses that have checked your credit in the last two years. When creditors and lenders review clients’ credit data for the purpose of an application, a hard inquiry is listed on the credit report. Too many hard inquiries can harm a credit score. The reason being is that credit grantors get nervous that they are not managing credit “responsibly.”

What's not included in your credit reports?

Contrary to popular belief, your credit report does not contain information about your checking or savings accounts, or your race, religion, gender, political affiliation, or personal lifestyle. Your credit report also does not contain medical history or criminal records.

(But, remember, your credit report is only one type of consumer report. As we've seen, there are specialized consumer reporting agencies that DO collect, maintain, and report some of this information. In addition, there are companies that provide what the FCRA calls an “investigative consumer report” which it defines as:

A consumer report or portion thereof in which information on a consumer's character, general reputation, personal characteristics, or mode of living is obtained through personal interviews with neighbors, friends, or associates of the consumer reported on or with others with whom he is acquainted or who may have knowledge concerning any such items of information.

Fortunately, the FCRA requires that these companies notify you if they prepare an investigative consumer report about you. Although this is something to certainly worry about, let's stay focused on credit reports for now. Just remember that credit reports and investigative consumer reports are different.)

Finally, your credit report may also not contain information from all of your creditors. As we talked about above, some of your creditors may not report to all of the credit bureaus, and some may not report to any credit bureau. Therefore, parts of your credit accounts and history may appear in different credit reports, or not at all.

Where does the information come from?

Now that you know who creates the credit reports, let’s talk about where the information comes from. Although the information may come from many places, it generally comes from three sources – you, your creditors, and public records. Let’s look at each of these sources and the information that they provide.

You

Yes, you! You unknowingly supply a great deal of information to the credit bureaus. How? Generally this happens when you apply for credit.

When you apply for credit, you typically complete a credit application in which you supply your full name, Social Security Number, current and former addresses, and current and previous employment. And guess what your potential creditor does with the information you listed in the application? That’s right. They send it all to the credit bureaus. This information then becomes a part of your credit file. Therefore, it’s important that you accurately complete this information on any credit applications that you complete.

Your Creditors

Your current and former creditors also provide information to the credit bureaus about you. These creditors tell the credit bureaus how you’ve paid your bills each month. But, not all of your creditors report all of your payment history to the credit bureaus.

Some creditors, sometimes called “automatic subscribers,” report all of your payment history to the credit bureaus every month. Other creditors, sometimes called “limited subscribers” only report certain types of information – like delinquencies. Let’s look at these different types of creditors.

Automatic Subscribers

Automatic Subscribers are creditors that regularly report information to the credit bureaus about your account with them. This information generally includes the date when this creditor opened the account, the total amount of the debt or credit limit, the current balance, and your payment history – good or bad.

There are many different types of automatic subscribers, including banks, credit unions, department stores, finance companies, and major credit card companies. But, just because a creditor is an automatic subscriber to one credit bureau, doesn’t necessarily mean that the creditor will report to all of the major credit bureaus. That’s one reason that the credit reports produced by different credit bureaus very often contain different information.

Limited Subscribers

Limited Subscribers are creditors that do NOT regularly report information to the credit bureaus. Instead, these creditors may only report certain types of information – like delinquencies or collection activities. They generally do not report good credit information, usually just bad information.

There are many different types of limited subscribers, including apartment management companies, insurance companies, utility companies, medical providers, and collection agencies. As with automatic subscribers, many limited subscribers may only report information to one of the national credit bureaus. Therefore, bad information reported by a limited subscriber may only affect one of your credit reports.

Creditors That Do Not Reports to Any Credit Bureau

Finally, there are some creditors that do not report to the credit bureaus AT ALL. This means that any information – good or bad – will not show in any of your credit reports. Typically, these creditors include individuals, like landlords, or small companies. (When you’re trying to improve your credit in later chapters, you need to be aware of creditors that do not report to the credit bureaus. These creditors will NOT help you to restore your credit. We’ll talk about this later.)

Who can see your credit reports?

Under section 604 of the FCRA (15 U.S.C. section1681b), only certain people may access your credit report, and then only for certain specified reasons. Generally, this means prospective creditors. However, there are many reasons that someone may access your credit report. For example, with restrictions, a potential employer may access your credit report when you apply for job.

To get a sense for this, let’s look at the list of “Permissible Purposes of Consumer Reports” as set forth in section 604 of the FCRA to find out who can see your credit report.

1. A court or federal grand jury;

2. You;

3. Someone (a creditor) that intends to use the information in connection with a credit transaction;

4. Other individuals or companies that intend to use the information in connection with employment, the underwriting of insurance, or certain government benefits;

5. Other individuals or companies that have a legitimate business need for the information in connection with a business transaction initiated by you;

6. A state or local child support enforcement agency;

7. An agency administering a State plan under section 454 of the Social Security act to set an initial or modified child support award.