Want to rent an apartment or buy a car or home sometime in the future? Chances are a lender will be pulling your credit report to determine whether or not to lend you money or extend you credit.
A negative credit history will make matters worse. A negative credit history remains on your report for seven years (including a defaulted student loan) and some bankruptcies for 10, which is a long time to wait when you need credit now. So next time you reach for that credit card, remember: Someone is keeping score.
What Excites a Lender?
What Scares a Lender?
In our continuing bid to increase our knowledge of credit reports and credit scores, we should understand how lenders use credit reports to determine the four Cs of credit.
Using a credit report helps a lender determine the following:
Capacity
Capacity is the ability to repay a loan. Lenders want to know the borrower's:
- debt level
- income sources
- length of employment
Character
Will the borrower repay the loan? The lender looks at:
- types and amounts of credit used
- timely payments on bills
Collateral
Capital
Is there something of value that the borrower agrees to surrender if the loan is not repaid?
Capital is another word for the borrower's accumulation of wealth, measured in terms of:
- net worth
- other assets that could be used to repay the debt
What Excites a Lender?
Knowing credit reports are "graded," what do lenders look for that demonstrates you will be a safe credit risk?
Lenders like to see stable employment or class schedules. Stable employment shows you're consistently earning an income, and a stable class schedule shows you will be consistent and responsible once you're employed.
Lenders will look at your class schedule to help determine the likelihood of you repaying your debt. If you continually go to class, then the probability is you'll go to work everyday and earn an income.
Student loans are your first opportunity to establish a good credit rating. Showing responsible student loan debt management demonstrates responsible borrowing and will help you achieve a good credit rating. Repaying your student loans on time is an excellent way to establish a good credit rating right after school.
What Scares a Lender?
Obviously, if you have late payments on your credit report, that's not good. Other things that may scare a lender include:
- Many opened accounts (even if they're not used) because there's the potential to charge to the limit.
- High balances—even if you're paying on time—you might be on the edge and not able to handle one more loan payment.
- Recently opened accounts could be perceived as desperation... you may be getting ready to rack up a lot of debt soon.
- Unpaid loans show that the last lender didn't get their money back, so why would a new lender want to take a chance?
What is a Credit Report?
Obtain a Credit Report
What's in Your Report?
Checking Your Report
A credit report is a history of your ability to manage credit. Think of it as a transcript. Just as your academic transcript shows your school grades, a credit report shows your credit grade.
Lenders report your payment history, amount borrowed, credit limits, and delinquencies to credit reporting agencies every 30 days.
Obtain a Credit Report
As of September 1, 2005, consumers everywhere in the U.S. will be able to access one free credit report each year.
How do I order my free report?
It's easy. The three credit reporting agencies have set up:
- A central Web site: www.annualcreditreport.com
- A toll-free telephone number: 877.322.8228
- A central mailing address:
Annual Credit Report Request Service
P.O. BOX 105283
Atlanta, GA 30348-5283
Do not contact the credit reporting agency directly; free reports are only available from one of the above methods.
Make the most of your free Credit Report 
—EDFUND brochure
What's in Your Report?
Although each credit reporting agency formats and reports this information differently, all credit reports contain basically the same categories of information: personal, credit history, public records, and inquiries.
Personal information
- Name, date of birth or Social Security number
- Current and previous addresses and telephone number
- Current and previous employers
Credit history
- Retail stores
- Banks (including defaulted student loans, if applicable)
- Finance & mortgage companies
Public records
- Tax liens and bankruptcies
- Court judgments (including child support judgments)
Inquiries
- Other authorized parties who have received your credit report
Your report does not contain:
- Your race, gender, religion or national origin
- Checking or savings account information
- Medical history
- Major purchases paid in full with cash or check
- Business accounts, unless you are personally liable for the debt
A credit misconception
Negative records such as collection accounts, bankruptcies and charge-offs will remain on your credit report for seven to 10 years after they are first posted. Paying off the account before the end of the set term doesn't remove it from your credit report, but will cause the account to be marked as "paid."
It's still a good idea to pay your debts: It can improve your credit score, but the major improvement will come when the record expires.
Checking Your Report
You should make sure the information on your credit report is accurate. Not only is your credit score based on this information, but lenders also review it to make credit decisions.
Review your credit report from each credit reporting agency at least once a year, especially before making a large purchase, like a house or car.
Need a reason to check your credit report? Here's one: 76 percent of credit reports have errors (Consumer Credit Counseling).
Things to look for on your credit report include:
- Name, address, birth date, Social Security number, etc.
- Verify the accuracy of accounts—are the accounts listed ones you opened?
- Are the balances correct?
- Are accounts showing late payments when you really paid on time?
- Call the credit bureau and the creditor as soon as you notice a mistake.
What is a Credit Score?
What Determines Your Score?
Chance of Default
Think of it as a test score - the higher the score, the better the grade. The more negative marks on your credit report, the more points taken off of your score.
Once a creditor has your score, they assign you a letter grade. This letter grade translates directly into the rate and term you'll receive on any loan you apply for. The grade estimates the likelihood that you'll pay back future loans.
Grades of loans:
• A — the most creditworthy borrower
• B — the average borrower
• Sub Prime — highest risk borrower
More information on credit scores from My FICO
A and B grade loans are for good borrowers. Most top banks lend to the As and Bs of the world only. Those with less-than-perfect credit are lumped into the sub-prime category.
Just like bad high-school grades limit your choices of colleges, bad credit grades/scores limit your choice of banks.
Credit scores allow creditors to make a fast decision about your creditworthiness with less chance of discrimination or subjectivity.
What Determines Your Score?
The two biggest contributors to your credit score are amount owed (30 percent) and payment history (35 percent), totaling 65 percent. 
Think about it: These are the top two criteria that help determine whether you're going to pay your next loan.
If you already have a bad payment history and owe a lot of money, the odds are that you're not going to be able to handle another loan. The opposite is also true... if you owe very little and you have an excellent payment history, the lender would want to loan you money.
Other factors included in a credit score: credit history length, the types of credit you already have and any new credit you may have.
Chance of Default
The purpose of a credit score is to determine whether or not you will repay a loan.
According to my FICO, if your score is 750 - 799 the chance that you'll default is two percent. Another way to think about this is from a lender's point of view. For every 100 people they loan to, two will default. Lenders charge more interest to those with lower scores in an attempt to recoup the money loaned out.
If your score is below 500, there's an 87 percent chance you'll default.
Student loans don't require a credit check, if your score is below 650, you're most likely getting a loan that most lenders would otherwise not provide.
How Your Credit Score Affects Future Purchases
Many large purchases can only be made with the help of loans. Most people will buy a car or a house by taking out a car loan or a mortgage. Having a good credit score will make those purchases cheaper as the lender charges you less interest.
Buying a Car
Buying a House
Debt-to-Income Ratio
- If someone with excellent credit bought a new car at a five-year term, the payment would be $377 a month at 4.97 percent interest.
- But the same car purchased by someone with not-so-good credit would cost $514 a month at 18.56 percent interest.
If you have good credit the extra $137 could pay your student loan payment or your car insurance.
Over the life of a loan, you could pay an extra $8,220! See how a credit score can affect your future purchases?
Loan Savings Calculator from the My FICO Web site
Buying a House
The real value in a credit score is the amount of money you can save with a good credit score.
Suppose you want to buy a $200,000 house.
- With an excellent credit score, your monthly payment is $1,157 a month at 5.67 percent interest.
- With a not-so-good credit score, your payment is $1,651 at 9.29 percent interest.
That's almost $500 more a month! Over the life of your loan, you could pay almost $178,000 more in interest!
Debt-to-Income Ratio
Credit reports and scores are only one part of the equation lenders use when determining whether to give you credit. Another consideration is your debt-to-income ratio — your total monthly minimum payments divided by total monthly gross income. The more of your income that goes to making debt payments, the harder and/or more expensive it will be for you to get another loan.
To determine your debt-to-income ratio, add up your minimum monthly payments for all your loans/credit cards, plus your rent or house payment. Then, divide this number by your total (before taxes) monthly income. The result is your debt-to-income ratio.
68 percent of Americans own their home. A few years after graduation, when you decide to buy a home, lenders will look at your debt-to-income ratio.
The typical, standard debt-to-income ratio lenders like to see for home loans is two numbers... 28 percent and 41 percent.
28 percent means that your total house payment (the loan payment, interest, taxes and insurance) can be no more than 28 percent of your total monthly income (before taxes).
41 percent means that your house payment, combined with any other debt you have, can be no more than 41 percent of your monthly before-tax income.
Even if you had a perfect credit score, a lender would be hesitant to give you a home loan if your total debt-to-income ratio was greater than 28 percent for your house or 41 percent for your house and other debt.
Why do you care about establishing good credit now anyway? Because your good credit habits will pay off in the future when you need it the most.
• More apartment/house choices:
If you're looking to rent an apartment or rent a house, your good credit will offer you a wider choice. A bad credit report may limit you to less desirable areas of town.
• Open a checking account:
More banks are requiring a credit check when opening a checking account or getting an ATM card. If you've bounced checks to your creditors, have unpaid bills, and made late payments, they may choose not to do business with you.
• Better job opportunities:
More and more employers are looking at credit reports before hiring. If you plan to work in a bank, some government jobs, or any job involved with money (like accounting) or security clearances, then the odds are your credit will be checked.
• Fast loan decisions:
Good credit gives you more choices of lenders, but you'll also qualify for lower interest rates and faster decisions. If you have perfect credit, there's nothing for a lender to question. However, if you've missed a few payments here and there, a lender will want an explanation.
• Increased purchasing power:
Those car deals that advertise no money down and 5.9 percent interest apply to people with good credit. Your good credit earns you a lower interest rate and you may not need to come up with a down payment.
Secure the benefits of your good credit by paying bills on time. Paying on time means sending the payment so that it is received by the due date... not sending the payment on the due date.
Use automatic payments/direct debits from your checking account to ensure bills are paid on time. Automatic payments also save postage, reducing time spent paying bills and many student loan lenders will reduce your interest rate 1/4 of 1 percent when you pay automatically.Another way to protect the benefits of good credit is checking your credit report once a year.
It's important to realize that even if you have excellent credit, there could be something on your credit report that sends a warning to a lender. With 700,000 identities stolen annually (Identity Theft Resource Center), combined with the high percentage of errors on credit reports, it's wise to check your report every year. How exactly is your identity stolen? Thieves go through trash—where they can find old receipts and bills.
To protect yourself against identity theft:
- Never give out any personal information over the phone unless you initiated the call.
- Don't carry your Social Security card.
- Never pre-print your driver's license number, phone number or Social Security number on checks.
- Shred anything that shows your name, address, and date of birth, Social Security number or personal account numbers.
- Follow-up with creditors when bills don't arrive on time. A missing bill could mean someone has used your credit card account and changed your billing address in an attempt to cover their tracks.
- Minimize the number of credit cards you carry. If your wallet is stolen it will mean fewer headaches.
- Order a copy of your credit report every year. Make sure all information is accurate and includes only those activities you have authorized.
If you become a victim of identify theft, the Federal Trade Commission recommends the following:
- Contact the fraud departments of each of the three major credit bureaus.
Fraud and Identity Theft - TransUnion
Credit Fraud Protection - Experian
Contact Equifax
Ask them to flag your file with a fraud alert including a statement that creditors should get your permission before opening any new accounts.
- Contact the creditors for any accounts that have been tampered with or opened fraudulently.
- File a report with your local police or the police in the community where the identity theft took place. Keep a copy for yourself or to provide to future creditors.
If you suspect you are the victim of identity theft, contact the Federal Trade Commission (FTC)'s Identity Theft Hotline at 877.ID.THEFT or complete the FTC Complaint Input Form.
For more information about account fraud and identity theft visit the Website of the Federal Trade Commission. They offer an extensive library of resources and information.
Opt Out of Offers
As a consumer, you may choose to exclude your name from consumer reporting agency lists for unsolicited credit and insurance offers. This is called opting out.
Opt out of credit offers or call 888.567.8688 (1.888.5OPTOUT).
You can also add your phone number(s) to the government's "do not call" list to reduce the number of credit and other telephone offers.
By opting out of offers, there's less risk of someone stealing your mail and your identity.
• Back to top