What Is A Credit Score?
For adults who are just entering into bank affairs, let’s break this down. If you own a credit card, borrowed a loan, or have a credit account, you most likely have a credit report. A credit report is a log of how you govern your money. This data is then processed and used to calculate your credit score. This credit score is utilized by lenders for them to judge how risky of a client you are. Although this may seem like a simple quantitative process, there is a lot more that goes into it.
Why Is A Credit Score So Important?
One would wonder why one small number is so important. But your credit determines a lot more than you think. It affects multiple aspects of your life.
A good credit score is vital when you move and attempt to settle. A case like this would include buying a house. This is one of the biggest steps a person makes in their life, however, it can be a fairly difficult one if you do not have a steady credit score. With the recessions and failing markets, banks have been hesitant to lend money. Despite the housing market reviving, the banks have raised the qualifications and specifications for lenders. With the high demands of the bank, one would resort to renting a house for the time being. Well, that too requires a credit check, the landlords may demand a bigger deposit or not let you rent the apartment or house at all if you have a bad credit score.
Similarly, purchasing a car also is an important investment. It is a very common purchase amongst the population as well. The money required for buying a car is much lesser than a house so although it might be easier to purchase one with a bad credit score, it also means you qualify for higher interest rates and a larger down payment. Just because of a bad credit score, you will have to pay thousands more to purchase the same vehicle. Not only this but after the purchase of the vehicle, you will need an auto insurance policy. Most, if not all, insurance companies check your credit scores to calculate your payments. So, a bad credit score will cost you here as well.
If you are contemplating starting a business and need to borrow money, your credit score will determine whether you qualify for small business financing or not. The purpose of your lending is irrelevant I.e. it does not matter if you are using the money to expand your already standing business or you are starting from scratch, your credit score is the only factor in determining your eligibility for the loan.
Just like that, if you have been searching for a job, it is also very common for employers to run through background credit checks for potential employees. This is more applicable in the government and financial sectors. A bad score or history could prevent you from getting your ideal job.
Now, by chance or good luck, if you do make a purchase even with your bad credit score you have qualified for higher interest rates. That means paying much more for an item than need be. This is how banks reduce the risk of lending you money.
What Affects my Credit Scores?
There are multiple factors that affect your credit score, each varying in degree to their relevance. Most commonly the credit score is determined by 5 factors.
Payment History covers about 35% of your credit score, outweighing all 4 factors. The main problem is the late payments, which have a big effect on your credit score. Recent payments have a higher effect than others and hence, recent more late payment means a lower credit score rating. A low payment has the ability to drop your score as much as 100-points.
Current and due debt on your account is also a very vital factor in determining your score. It covers around 30% of your credit score report. It is a simple record of how much of your credit limit you have consumed. For instance, your balance is $1000 your credit limit is $5000, this means your balance to limit ratio is 1.5 to or 20%. This is measured in all revolving accounts as well as individual ones. Hence, the higher the balance to limit ratio, the more negatively it impacts your credit score. It is better if one reduces their credit card balances and that will allow the credit score to rise higher.
Types of Credit
This covers around 15% of your credit score. This is called credit diversity and is a record of the variations of accounts under your credit. If you have multiple loans, mortgage, student loans, and multiple credit cards then that implies that you are a good credit risk than someone who has, for example, only one credit card and a student loan. The more diverse you’re your card is, the better the credit score.
Credit History / Credit Age
These factors for around 10% of your credit score. Credit History is simply a measure of the duration that you have had credit for. It is measured by calculating the average age of all of your credit accounts. The longer you have had credit, the higher is your score.
New Credit Checks / Credit Inquiries
This accounts for a rough 10% of your score. This keeps in check the new credit accounts that have been opened or the requests or inquiries for more. Each inquiry lowers your credit score and is recorded on your credit for the next 2 years. However, the inquiries only affect your score for a year. A way to fix this issue is to be careful and only apply for credit when it is necessary.
Checking your points through NAV does not affect your scores.
What does not Affect my Credit Score?
Now, in contrast to what has been mentioned above, it is important to know what details do not affect your credit score. It is important to remember that your credit score is a representation of how well you handle your finances as an individual, but not your associations as an individual. For example, your status, race, gender have no connections to your credit score. Likewise, even your salary or your employer is irrelevant to your credit score.
Will I have the Same Score in all Three Bureaus?
There are three main bureaus that collect and analyze credit reports and scores. These are the Trans Union, Experian, and Equifax, these companies merge your data which is then used by mortgage companies, landlords, credit card companies, etc. It is very common and often confusing for an individual when your one score represents a high score yet your request for a loan is still denied. Now that is due to the fact that the bank company or financial institution is not using the same report as you. All institutions do not use the same Credit Agency and it’s a common issue that the information is different in the report from each bureau.
How are my Scores Calculated?
There are variations in scores as they differ between different bureau and lenders. This because of how they have been calculated. The 3 major bureaus are credit reporting agencies and credit data repositories. This means that collect credit information on Individuals as well as businesses from creditors across the country. The information that these agencies receive is then used to create credit reports and credit scores in your credit file.
But if all the bureaus gather the same data, why is it that the scores differ between the three of them?
This is because although the 3 bureaus receive the same information, for example, your cell phone bill, car utilities mortgage payment and car bills, they all hold a different proprietary system that comes up with your score.
An example of this would your score at Experian might be lower than the one at TransUnion because TransUnion pays more value on your regular mortgage payments than your late car payment.
Why are my Scores Different?
Different Credit scoring systems are used by different financial and other risk calculating institutions. The most widely known is called the FICO score produced by the Fair Isaac company. It is the most commonly adopted amongst financial institutions and owns the gold standard in credit scores.
In spite of their own FICO score, all credit bureaus have their own proprietary scores. The main credit bureaus have also invented the Vantage score as a joint venture which stirs competition with the FICO score.
Each bureau also has its credit score ranges.
- Vantage score 3.0 and 4.0 300-850 (781-850 is preferred)
- FICO score 8 and 9 300-850 (800-850 is preferred)
- Industry-specific FICO score 250-900 (800-900 is preferred)
All scores would be different based on the importance weighed on different credit transactions. An example would be that FICO might consider your car payment to have more weight than your debt in comparison to VantageScore. Hence, both scores will be different.
In addition to this, larger financial institutions have created their own proprietary scores which are unavailable to the common public. The purpose of each score is to calculate the risk of an individual or business based on their credit report.
Furthermore, there are two other causes of your credit score being different.
Credit scores are calculated in real-time. This means that when a purchase occurs, the bureaus use their algorithms which produce a credit score. But since this all happens in real-time, there is a possibility of frequent shifts on your score depending on what has been reported. For example, if you have paid your master card bill on a certain day, your score will differ greatly between the day before you paid versus the day after. Hence, the change will be significant depending on the portion of debt paid off.
Varying Information Between Bureaus
All credit companies do not provide data to all bureaus. This means that all bureaus do not hold the same amount of information. Since credit scoring companies are completely dependent on the information on your credit profile, if it is different between the bureaus then the overall score will be different as well. For instance, if your MasterCard reports to TransUnion and not to Equifax then your credit balance and credit limit will be higher on TransUnion than in Equifax. This will produce a different score for each bureau.
Which Score to Use?
The VantageScore came to being in2006 to play as a competitor to FICO which was the dominant Credit company since 1989.
FICO scores are the most commonly used credit scores for reaching financial conclusions in terms of loans, interest rates, and other credit accounts. FICO claims that more than 90% of decision-making done by financial institutions and data audited by third parties is based on FICO scores.
On the other hand, VantageScore believes that over 2800 organizations, 2500 of them being financial institutions, utilized 10.5 billion of its scores between 2017 and 2018. The utilization mostly came from credit card companies that manage potential applications and existing accounts.
VantageScore and FICO use identical if not similar data to conclude your score. Both of them include your outstanding debt, payment history and other financial information to calculate your risk. But most importantly, they both use a score that ranges between 300 to 850.
Now, although they use the same date, the algorithms of each system differ. Both FICO and VantageScore use numerous editions which also present themselves as the differences you see in your scores. Not only this but each, FICO and VantageScore have different weights (weightage) assigned to different factors. The difference in the influence of each factor can also result in different scores.
- Most weightage: Payment History of loans and credit cards
- High weightage: Total amount of debt owed.
- Moderate weightage: Length of credit history
- Least weightage: New Credit and Credit Mix
- Most weightage: Payment History
- High weightage: Age of credit type of credit, credit to limit ratio
- Moderate weightage: Total balance and debt
- Least weightage: Recent credit behavior and inquiries, available credit.
An advantage that comes with VantageScore is that the scores can be accessed for free whereas, for FICO, you would have to pay between $20 to $40 a month, depending on the level of monitoring you want. And the money you spend could be a complete waste if the lending company decides to use another score to measure your risk.
The Problem with Incorrect Scores
On average, one in 5 individuals has an error in their credit scores which makes them look more unsafe than they actually are. The consequence of this is, of course, bigger deposits and higher interest rates by the lenders.
One would assume that with the amount of money at stake, accuracy would be prioritized, but it is not. The speed and volume are. The return on investment for correcting the errors in the data is not greater than the cost for the bureaus.
The three major bureaus have over 200 million credit files, each containing on average 13 past and current information. Hence, accounting for nearly 2.6 billion pieces of data. Every new month, new data in billions requires updates which call for a quick system. The amount of data that needs immediate process coming from a variety of sources makes it impossible to not have errors.
Although it might seem that credit bureaus are to blame, they are not only at fault here. The customer is as well. It does not fall on the credit bureaus to negotiate the dispute. The job of the credit bureaus is to collect information from the creditors and develop a report from the provided numbers. Often the creditors themselves do not provide the right information, for example, more than half of the hospital bills are inaccurate and debts are never properly accounted for, for example, an unaccounted mortgage payment. If you reach out to the bureau with a complaint about an error, their legal duty is to consult the creditor, asking if they stand by their claim and if the credit is due. If the creditor says that the customer owes them money, the credit bureau has no choice but to account for it.
This is when the responsibility falls on the consumer. There needs to be a demand to regularly check the credit reports to analyze the data and look out for errors. After a long and hard battle, Congress has allowed one free credit report for an individual per year. This quickly gained popularity and utilized by over 40 million customers. When they see an error on their reports, only then can customers take action against it. It is reported that for the three main bureaus, there are complaints about inaccurate information at least eight million times a year.
The financial institutions and lenders who have already given out money trust their credit proprietary systems. Credit reporting and collection is a large industry and requires a big financial investment alongside a halt in the current transactions. The bureaus do not have the incentive to pay the fees required to make the change. They trust their algorithms and believe their system produces accurate credit reports and scores. Since there are no other options, customers have no choice but to resort to these faulty systems.
Given this, it is expected that consumers are frustrated with the credit report system. It is the second biggest complaint handled by the Consumer Financial Protection Bureau. The main reasons were incorrect information on a credit report which accounts for 74% of the complaints. The other complaints include the credit bureaus’ investigation of a complaint. This covers about 11% of the remaining complaints. Most of the consumers are now demanding new laws and regulations regarding the errors of the bureaus. Here are 3 possible solutions that policymakers can take
Annual Access to Credit Reports
Since the credit system is reliant on customers to search and point out errors in their own reports, it is crucial that they must have access to their reports. Whether through email or post, the credit bureaus need to make sure that all the reports have been sent to their customers. This would be a solution for customers who are unable to access their reports online due to security freezes or inaccurate information.
Create Penalties for Bureaus and Customers
No one is punished besides the customer if there is inaccurate information. The Law only demands the bureau to question the creditor’s claim. There needs to be a penalty on the creditors who repeatedly provide inaccurate information. This would then push the credit companies to conduct investigations and ensure accurate information in the future. Even if a few companies are investigated and penalized, the fear of defamation and fines would drive others to modify their systems for more accuracy. For those customers who try to wipe out legitimate debts by filing incorrect appeals, penalize them as well. This would eliminate errors on both sides of the system and result in a cleaner and more accurate act in the future.
Increase Competition and Lower Barriers to Entry
An increase in the variety of information that credit scores utilize and credit reports contain could help the system. An addition to the already collected information could be rent and utility bills r remittances transferred to the family. This could reveal vital information regarding creditworthiness. The bigger three bureaus benefit from having an established name and standards in the industry hence, being more relevant. This doesn’t allow the new bureaus with newer standards to gain a market.
Policymakers must encourage competition through pilot programs or limited guarantees that uses the newer alternative credit reports and data. The promotion of competition will lead to growth in innovation and efficiencies in the credit industry.
This is why it is commonly recommended to monitor your reports annually to keep an eye out for errors. You should also utilize the advantage that you are granted which is one free annual credit report. Not only this but make sure you are utilizing a monitoring service. Trans Union has one of the most upgraded and inventive services like Instant Alerts and Credit Locks. Utilizing these services will save you from potential inaccuracies and fraudulent behavior that could ruin your credit score.
The Importance of Monitoring your Credit Score.
Why Should you Monitor your Credit Score?
Monitoring your score can be easy, quick, and inexpensive. For all the above-mentioned reasons, it should be highly recommended that one should monitor their scores. It could just be that 2 of your scores are perfectly fine while one bad score ruins your chances of getting approved for a loan. This only isn’t important because your finances should be under check but also because identity theft is common and fraudulent activity and potential errors on your reports can drop your credit scores.
There are 3 main options that can be used to monitor your scores.
- You can do it yourself: Ask for copies of your scores and go over them yourself.
- Utilize a free service: There are numerous services that you can entail to have a monitoring service check your credit reports for free.
- Pay for a service: There are services that you pay for that monitor your reports at any allotted time and inform you of any irregular or potential erroneous activity.
Do It Yourself:
This is a long and labor-intensive method. However, you can use one of the few free services available
American Express Credit Guide. This will show your:
- Current balances
- Credit limit Utilization
- Total Available Credit
- Number of open accounts
- Number of Recent Hard Credit Inquiries
Capital one: Credit-wise. This will show your:
- Payment History
- Oldest Credit Line (not average age of accounts)
- Recent Inquiries
- Credit Used
- New Accounts
- Available Credit
- Accounts and Balances
- Personal details
Chase: Credit Journey. This will show your:
- Account Summary
- Personal Information
- Public Records
Paying for a Credit Monitoring Service
Not everyone believes in their ability to find inaccuracies in their reports nor do many have time it requires. In that case, you can use a paid monitoring service. Paid services charge a monthly fee and go through the reports at requests and inform about any errors or potential fraud. They include some of the free services along with extra services as well.
FICO Basics 1B
- Only includes the Experian report
- Monthly credit report updates
- Includes FICO Score 8
Cost per month is $19.95
FICO Ultimate 3B (quarterly reports)
- Includes all three credit reports
- Quarterly credit report updates
- 28 FICO scores included
- Identity theft monitoring
Cost per month is $29.95
FICO Ultimate 3B (monthly reports)
- Includes all three credit reports
- Monthly credit report updates
- 28 FICO scores included
- Identity theft monitoring
Cost per month is $39.95
What to do in Case of an Error in Scores
Since errors and mistakes are sadly common in credit scores and reports, what should you do if you come across one?
Contact the Credit Bureau
Once you come across an error on your reports, it is recommended by the Consumer Financial Protection bureau to contact the three major bureaus (TransUnion, Equifax, Experian) the error. You must dispute the errors on the credit reports either online or by mail
Provide your contact information and explicitly explain where you believe the error has occurred and why it is wrong. Also, attach supporting documents supporting your dispute. It is also advised by the Consumer Financial Protection Bureau (CFPB) to keep copies of any letters exchanged and if you are using mail, make sure it is a certified one with a return receipt.
Contact the Furnisher
Furnishers are the companies that provide the bureaus with the information, for example, banks and credit card issuers. It is recommended by CFPB that you contact the furnishers as well. Mail your dispute to the address or contact information provided by the furnisher, depending on the error, it will be faster if you directly meet the furnisher before the credit bureau. This will save a step but again, this is based on the error. If it is an identity-based error made by the credit bureau then, of course, it is best if you contact them first.
Wait 45 days for the Investigation
The credit bureaus have around a month after they receive the dispute to dig in and solve your queries. After that, they have to deliver you the information within the next five days.
If you have reported the dispute to the furnisher, they also have to investigate and report back within the next 30 days. But if the furnisher stands by its claim, they will not investigate further.
Review the Results
The bureau involved with the error will soon provide you with the results of the investigation. They will send it in writing alongside an updated credit report if your dispute has caused changes. The bureau will also provide the contact information of the furnisher that provided the incorrect information.
Check for Updates
Updates take time to appear on your credit report. It is heavily dependent on the credit bureau’s update system and speed. It is also reliant on the furnisher and the time they take to send the updated report to the bureau. If your report hasn’t been updated in several months, then report to the relevant bureau and furnisher.
The complexities regarding credit scores and the number of financial institutions involved make it a hard concept to grasp. While it is technical and daunting, it is very important to be careful with your score reports regardless of wherever you receive them. It is crucial to understand the data that is being reported and avail as many monitoring tools as you can.
Alongside this, use the free services mentioned above as much as you can so you understand the information and can report errors as soon as possible before they negatively impact your credit score.