Consumer Credit Basics - Your Questions, Answered
We've all heard that our credit score can affect our ability to purchase a home, buy a car, or qualify for a credit card – but there are quite a few common misconceptions about how this information is obtained, calculated, and applied to assess one's actual creditworthiness.
I've put together this list of common questions regarding consumer credit, to help you understand the basics – and recognize the impact of credit scoring and reporting to your financial future.
- What is a credit score? A credit score is a three-digit number which provides a snapshot of your potential financial risk. Lenders then use this number when deciding whether or not to extend credit.
- Who might want to review my credit score? Mortgage lenders, landlords, credit-card issuers, cell phone providers, utility companies, insurance agents – the list is extensive. The short answer is: anyone who might want to know whether you’re likely to be a risk when borrowing money, or buying on credit. That's why it's important to familiarize yourself with the best practices for maintaining your credit score, and stay informed when it comes to your personal credit history.
- What's the difference between my credit score, credit report, and credit history? Your credit history is the record of your loan and bill payments, over time. This information is gathered by consumer reporting agencies, who organize it into a report – which is then made available to lenders for the purpose of assessing your individual creditworthiness, or potential risk. In short, your credit history is used to calculate your overall credit score – and both are included in your credit report.
- Who are the consumer reporting agencies? The three major U.S. Consumer credit bureaus are Experian, Equifax, and TransUnion. They gather information about your credit history from lenders, vendors, and financial institutions, so they can provide an accurate snapshot of potential credit risk.
- Are all credit scores the same? No. Each of the three reporting agencies listed above uses a different algorithm for calculating your credit score. And, because they operate independently, information provided may vary from agency to agency – which means there may be inconsistencies or discrepancies in reporting when you review and compare information provided by all three agencies, side-by-side.
- Will applying for new credit negatively affect my credit score? It certainly can. Multiple lender applications or inquiries for credit within a short period of time can be an indicator of financial distress, so lenders look for this information when assessing their risk. If you have little credit history or few accounts, applying for several lines of credit in close proximity can trim points off of your credit score.
- What if I am looking to buy a home, shopping for a car, or applying for student loans? Will those inquiries negatively affect my credit? According to FICO, multiple inquiries for these types of loans will not negatively impact your credit – as long as they occur within close proximity. You have 45 days to shop for the right loan – inquiries for these types of credit received during the 45 day time period will be consolidated to reflect as one single request.
- What criteria are used to assess risk? Each of the consumer reporting agencies uses slightly different criteria – however, common concerns include your history of repayment, presence of bankruptcy or outstanding collections, and current credit utilization (which assesses how much credit you have, total, compared to the amount of credit currently available for use).
- What factors are NOT used to assess creditworthiness? Surprisingly, your income and employment status are not considered when assessing your credit score. There are also some factors which are expressly prohibited from use in calculating credit scores, in order to avoid discriminatory practices - such as age, ethnicity, marital status, geographic location, and other personal information.
- If I check my own credit report, will it negatively affect my score? No. Consumers are given the option to check their own history once a year through any of the consumer reporting agencies, at no cost. A request to check your own score is recorded as a “soft inquiry", which has no impact on your score. (This is also true of inquiries which come from businesses with whom you already hold an account – it allows them to extend promotional offers and incentives for existing customers in good standing, without negatively affecting your score.)
I know this is a lot to keep track of – but there are a lot of resources available to help you keep up-to-date on your personal credit status.
Don’t be fooled into believing you need to pay for this information - these days, most banks (and even some credit card companies) offer free credit monitoring services. Using these free services can help you keep track of your credit score and financial history, so you can make sure you'll have access to extra resources when (or if) you really need them.