In the current business environment where people are becoming increasingly dependent on credit in transactions, it is critical to monitor and understand the basis for credit reports and scores. Credit scores are used by creditors, insurers, employers and other businesses to evaluate an individual’s applications for credit, insurance, employment, or renting a home. A credit report includes such personal information as the manner in which bills are paid and whether an individual has been sued or filed for bankruptcy. This information is used to calculate a credit score which affects whether you can get a loan, and the rates you must pay to borrow money.
There are several institutions that calculate credit scores, but the most common are referred to as “FICO Scores” because they are produced by Fair Isaac and Company. FICO Scores are based solely on information in consumer credit reports maintained at credit reporting agencies. These scores range from 300 to 850 and are calculated by an equation that evaluates the information from your credit report at a specific agency. There are three FICO Scores, one for each of the three credit bureaus: Equifax, TransUnion and Experian. One’s FICO Score may be different at each credit reporting agency since the information reported to them may differ. These credit scores may change daily, as information on your credit report is updated.
Although the computation of FICO scores is a closely guarded secret, a general guideline is as follows:
1. Payment History (35%): How bills are paid significantly affects your credit score. Timely required payments are crucial.
Amounts Owed (30%): The proportion of used credit in relation to the available credit you have for revolving accounts is key (“credit utilization ratio”). The higher the ratio of available credit used, the more it can negatively affect your FICO score. So, by closing an old or unused credit card, you may negatively affect your score by wiping away some available credit, thereby increasing your credit utilization ratio.
Length of Credit History (15%): The longer you’ve been using credit, the better for your score.
Types of Credit Used (10%): The score will be higher for a good mix of credit cards, installment loans, finance company accounts and mortgage loans.
New credit (10%): The average age of your various credit lines, as well as how soon you opened a new line of credit. Lots of new credit negatively affects your score.
The credit inquiries made on your report will also negatively affect your score. An inquiry hits your report whenever you allow a third party to check your credit history to obtain credit or service. Other relevant factors considered include bankruptcy, foreclosures and judgments, which affect scores significantly and generally stay on a report for seven to ten years.
In 1970, the Fair Credit Reporting Act (FCRA) was enacted to promote the accuracy and privacy of information in the files of the nation’s credit reporting companies. As amended by the Fair and Accurate Credit Transactions Act (FACTA) of 2003, the FCRA mandates each of the three nationwide credit reporting companies to provide you with a free copy of your credit report, at your request, once every 12 months. The Federal Trade Commission, charged with enforcing the FCRA with respect to credit reporting agencies, indicates that by law, “you have the right to a free credit report from AnnualCreditReport.com or 877-322-8228, the only authorized source under federal law.” You may order your reports from each of the three companies at the same time, or you can order your report from each of the companies one at a time.
Under the FCRA, both credit reporting companies and the organizations that report your information to them are responsible to correct any inaccurate or incomplete information in your report, so it is vital to monitor your credit report and dispute any errors with the credit bureau and reporting agency. This will ensure that the information therein is accurate, complete and current when applying for a loan for a major purchase, buying insurance or applying for a job. This practice is also important to help protect against identity thieves, who may use your information to open a new credit card account which becomes delinquent, thereby affecting your ability to get credit. It can take years to build up good credit, but it can take as little as a day to ruin it.
Spencer J. Rothwell is an Associate Attorney who practices in the Litigation, Land Use and Real Estate areas.