Credit Report and Score 101

You’re stoked. You found the perfect house and are ready to apply for a mortgage. The lending company then performs its due diligence and tells you you’re not qualified for a loan. You later discover that someone opened credit cards in your name and ran amok.

This is one of the main reasons why good financial hygiene involves regularly checking and monitoring your credit.

Why Credit Matters

Financial institutions prefer to be risk-averse when lending money. Before a lender or creditor will give you credit, they’ll likely check your credit report.

This report compiles a record of how responsible you handled credit in the past. And the more reliable you look to repay debts, the lower the interest rate you’ll receive on loans — thus you’ll save money in the long run by paying less to borrow money.

Checking Your Credit Report

The three major credit bureaus — Experian, Equifax, and Transunion — are legally obligated to each give you a free credit report at least once a year. You can retrieve these at annualcreditreport.com.

Pro Tip: Instead of getting all three reports at once, try to stagger them throughout the year so you have this flexibility if needed.

When to be Extra Vigilant

Below’s a scenario when it’s good practice to monitor your credit report with a little more scrutiny.

When you anticipate a loan on your horizon, like a 30-year mortgage, understand that the interest rate attached can really influence your financial net worth. The higher the interest rate, the more money you’ll pay to borrow money. Being on top of your credit report a year in advance could save you lots of money. Be more vigilant and access each one of your credit reports in a four-month period. For example:

▶︎ 13 months to go before loan: Retrieve your free report with Equifax.
▶︎ 8 months to go before loan: Retrieve your free report with Transunion.
▶︎ 4 months to go before loan: Retrieve your free report with Experian.
▶︎ 1 month to go before loan: Retrieve your free report with Equifax.

A proactive approach will allow you to clear up any errors in a prompt manner throughout the year versus dealing with unnecessary hassles at once as you’re trying to purchase a home.

Correcting Errors & Negative Information

When you retrieve your credit reports, you’ll see information in the file on how to report the dispute to the specific credit bureau. Try to dispute incorrect information as soon as possible because it does take time to resolve.

▶︎ The Federal Trade Commission provides guidance and sample letters on how to properly dispute errors.
▶︎ If you notice possible identity theft, review the guidelines at identitytheft.gov.

If the negative information is correct, then time will heal this wound — at least on your credit report. A credit report may give you flashbacks to your high school years because it’s an adult version of a permanent record. But most negative information (bankruptcies, late payments, etc.) stay on for 7-10 years

What’s In a Credit Score?

Now that you’ve got a handle on your credit reports, let’s dig into your scores. They can vary slightly from credit reporting agency to credit reporting agency. If you’d like to improve your scores, some common steps can help you boost them with all three of the agencies.

To understand how, you’ve got to know what the sections make up your credit scores, how they’re weighted, and how to improve each section.

▶︎ Payment History

The number of on-time — and late or missed — payments you’ve made. Since late or missed payments are a sign of risk to credit providers, this area is weighted as 35% of your credit score.

Ways to Improve

The easiest way to better this part of your credit score is to pay your bills on time. If you don’t have a history of late or missed payments but find yourself missing a deadline, call your credit provider. They may forgive an infraction like a late payment if you’ve only missed it by a short time, which can retroactively boost your score with the reporting agencies. Just try not to make it a pattern!

▶︎ Credit Use

The amount of debt you have on your lines of credit. As creditors want to see you actually utilizing your available credit — and how much of it you’re using — this area makes up 30% of your credit score.

Ways to Improve

If you’re utilizing too much of your credit — like maxing out all of your cards — it’s a sign that you may not be able to pay back what you’ve borrowed. Credit reporting agencies like to see you using 30% or less of your available credit to show you’re not a risk to lenders. So add up all of your outstanding debt, then divide it by your total available credit. If your credit use is above 30%, make a plan to pay down your outstanding debt. A goal of 0% may be unreasonable if you’re above the 30% mark.

After all, the point of having available credit is to use it! But, by reducing your outstanding debt, you can improve your credit score while reducing the amount you pay in interest.

▶︎ Age of Accounts

The length of time during which you’ve had accounts open. A history of open accounts shows creditors your level of responsibility with having and using credit. This area accounts for 15% of your credit score.

Ways to Improve

If you’ve reduced your credit use to below the 30% mark and are tempted to close out your accounts to avoid using those lines of credit again … hold up! Remember the importance of account age. Leaving your accounts open — even if you’re not using them — and letting them age can increase this area of your credit score. You may want to use them occasionally so they don’t close automatically due to lack of use. You can check with your credit provider to see how often you have to use them so this doesn’t happen.

In the case of credit cards, you might not want to cut them up for just this reason. Just don’t let temptation set in!

▶︎ Type and Number of Accounts

The types of credit you have access to, like loans and credit cards, and the number of lines of credit you have access to. Weighted at only 10%, this area of your credit score isn’t as impactful as the previous sections.

Ways to Improve

Similar to account age, closing out accounts you’re no longer using can reduce the number and type of accounts you have access to, which can hurt this area of your credit score. Creditors like to see that you can be responsible with multiple lines of credit — but that doesn’t mean you should submit multiple applications just to add more of different types (see the section below for more)! Just apply and use wisely and within reason to keep this area of your credit in check.

▶︎ Credit Application History

The number of lines of credit you’ve applied for — and whether your applications have been accepted or denied. Since the majority of your credit score is based on actual usage, this area makes up 10% of your score.

Ways to Improve

Applying for many lines of credit in a short period of time is a sign to lenders that you need a lot of credit … and that you might not be able to pay lenders back. Plus, application denials are a pretty clear sign that you’re not creditworthy. So, instead of submitting many applications and hoping for an acceptance, only apply for the lines of credit you really want or need. And if you’re denied, don’t let it get you down! Work with the credit provider to find out why you were denied and if you could turn that denial into approval with some tweaks, like a reduced credit limit.

Once you show that you’re trustworthy — through on-time payments, low credit use, and by leaving the account open over time — you will likely be able to increase your credit limit. This can lead to access to other types of accounts as well as more accounts, which can further boost your credit score when used responsibly.

A Credit Score’s Limitation

We see some clients initially obsess over their credit score as a method to analyze their financial health. Don’t get caught up in gauging your financial health by your credit score.

A credit score only matters in a few instances (applying for a loan like a mortgage, getting a new credit card, sometimes applying for apartments or jobs, your home and auto insurance premiums, etc.). These important events can influence your financial health over time but there are many other factors that go into your financial health.

Remember, a credit score doesn’t include your emergency fund, your psychology with money, your earnings, and savings strategy. The credit score gauges how reliable you are to pay back your debt.

This is why we advocate for you to see your financial net worth and your budget as your method for gauging your financial health.

Get Serious Before A Big Purchase

As you can probably imagine, improving your credit score can take time, and it’s not a one-and-done task. You especially want to care about your credit score whenever you envision a large purchase on the horizon.

The better your credit score = the higher your chance for a lower interest rate.

Continue to prove your creditworthiness through responsible use, and you should see your scores tick up slowly but surely.

This article gives you a glimpse of the “Debt Elimination and Credit Management” FPFoCo Academy module. Access these personal finance modules and so much more by becoming a client.