Every time you apply for a loan, you authorize the lender to get a copy of your credit report from one of the three bureaus: Equifax, Experian or TransUnion. Irrespective of the bureau, your credit report will always contain four categories of information, including personal information, credit history, credit inquiries and public records.
These details are sent to the bureaus by your past lenders and they’re used to determine your creditworthiness for future loans. Here’s a breakdown of each category and why they matter:
Information Found in a Credit Report
Your personal information includes exactly what you’d expect: your name, date of birth and social security number. Employment information and other details needed to identify you’re also included. Every time you apply for credit, you provide the lender with your personal information. Afterward, the details are sent to the credit bureau and they’re used to update your records. The personal information part of the credit report has no impact on your credit score.
Credit history contains information about every credit account you’ve opened. It shows the type of account (open, revolving or installment), when the account was opened, the credit limit on the account/the amount borrowed and the current balance on the account. It also includes credit history, detailing how you withdraw from your credit accounts and your repayment records.
Your credit history is the most important factor in credit score calculation. If you manage your accounts well, make timely repayments, and never max out your credit card, you should have a good credit score.
Every time a lender asks for a copy of your report, the credit bureau notes it down. These inquiries are listed in a section of your credit report and the section names every organization that has requested your credit report within the last two years.
Credit inquiries are divided into soft and hard inquiries. Soft inquiries are from organizations and lenders that requested your report without your authorization. Conversely, hard inquiries are from the lenders that you granted permission.
Credit inquiries have some effect on your score, and the more the requests, the lower your score. Luckily, soft inquiries do not count in credit score calculation and they are only visible to you. However, hard inquiries count because they are visible to your prospective lenders. A lot of hard inquiries in your report signals to lenders that you may be a credit risk.
The credit bureaus collect information from state and local courts to update your credit report. If an overdue credit card balance has ever been sold to a collection agency, the details will be added to this section. Same for people that have filed for bankruptcy at one time or the other.
Negative public records are bad for credit score. If your balance has ever been sold to a collection agency, the information stays on your credit report for seven years and during that time, you may never be able to secure financing from a lender. Chapter 13 bankruptcy remains on a credit report for seven years while Chapter 7 bankruptcy is removed after ten years.
Check your credit report regularly to make sure that all the information provided is correct. This ensures that lenders see the most accurate version of your credit score, increasing your chances of getting approved for credit/a loan. If you find any error in your credit report, contact the appropriate credit bureau and have it rectified quickly.
Criteria Used to Calculate Credit Score
The credit reporting bureaus use algorithms to calculate every user’s credit score. While the exact formula for calculating the score is not public knowledge, certain parameters are taken into consideration. Below, the parameters (and how much weight they carry) are outlined.
Payment History (35%)
This includes your credit history, your repayment history and any public records. If you manage your payment history well, your credit score improves quickly. If you miss payments, get sued for overdue payments or file for bankruptcy, the negative impact reflects quickly too.
Unpaid Balances (30%)
How much balance you have on your credit accounts also impacts your credit score significantly. The lower your unpaid balance, the better your credit score. The same goes for how much of your available credit you are utilizing. Credit utilization above 30% is not good for your credit score.
Length of credit history (15%)
The age of your credit history also impacts your credit score. The older your credit account and the more active the account is, the better your credit score.
Type of Credit (10%)
There are three types of credit accounts: open, revolving and installment. If you have a mix of the different credit types on your report, it impacts your score positively. Exactly how this affects credit rating is unknown. If you have managed different account types responsibly in the past, it signals to lenders that you can handle any type of credit account.
New Credit (10%)
How frequently you shop for new credit also affects your score. Having a long list of credit inquiries and owning a lot of new credit accounts is bad for your credit score. The impact is even more pronounced if you have a short credit history.
Other Credit Scoring Models
There are many credit scoring models in the industry, but FICO is the most prominent of them all. Nearly 90% of banks and financial organizations in the US use FICO scores to appraise credit card and loan applicants. FICO scores range from 300 to 850, with 850 signaling the highest level of creditworthiness. If your FICO is above 700, you have a good score.
The criteria above outlines how you can improve your credit score. The summary of it all is: pay off your balances regularly, don’t max out your credit account and don’t open new credit accounts indiscriminately. Furthermore, request for your credit report at least once per year. This gives you an overview of how well you’re managing your credit profile. It also allows you to work on changes that’ll improve your credit rating, as well as confirm that the details in your credit report are accurate.