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Credit Reports, Credit Scores, Credit Repair, and Credit Counseling
Although it’s true that improper use of credit can be disastrous, credit properly used can enhance your life.
Liz Pulliam Weston, Your Credit Score
If the mention of a credit report
a. makes your blood run cold,
b. produces heart palpitations,
c. causes profuse sweating of the palms, or
d. gives you an overwhelming urge to skip this chapter . . .
congratulations! You are perfectly normal. Most of us would prefer just about anything to a face-to-face encounter with our credit report.
Many people are so afraid to know what’s in their credit report that they choose denial over reality. As long as they don’t know for sure what’s really in that file, the possibility remains that it’s not that bad.
Many people simply do not understand what a credit report is, that they really have one, where it is, who can look at it, or why it matters.
Some naively trust the supreme credit bureau in the sky to have their best interests at heart. These folks believe that, because they pay their bills on time, their credit report is automatically a mirror image of such exemplary behavior.
Unfortunately, in this electronic age, opting out of the credit reporting system is not a possibility. We have to learn how to make it work most effectively for us.
Having credit and being creditworthy are not synonymous with having debt or being in debt. Credit is a good thing; debt is not. When it comes to your personal credit, if you prepare and prevent, you won’t have to repair and repent.
Credit Reports
To understand a credit report, you must first know about a credit reporting agency (CRA), also known as a credit bureau. A CRA is a profit-making company that gathers, compiles, and analyzes credit information about individuals and then offers it to banks, mortgage lenders, credit unions, credit card companies, landlords, and employers so they can determine the creditworthiness of a customer. There are hundreds of them, but the big three are Equifax, Experian, and TransUnion.
Every adult has a credit report (also called a credit file from pre-computer days when credit information was actually stored in file folders). Think of yours as a rap sheet containing information that may or may not be true. Compiled by a credit bureau from information received from untold sources, your report is a list of allegations others have made about the way you conduct all aspects of your life, which could include things that are not of a financial nature (i.e., judgments, tax liens, and other matters of public record).
Whether you are married, separated, divorced, or single, your credit file should contain information about you only. Information about others, including your spouse, will appear only where that person is legally obligated with you on an account.
You should review your credit report at least once each year. By law, you are entitled to receive one free credit report from each of the big three CRAs each year, provided you order your credit reports from AnnualCreditReport.com. This is your opportunity to assess their contents, to make sure there are no discrepancies, and to determine if the information is factual. If you find something wrong, you have the right to dispute it. Instructions on how to file a dispute will be included with the report. While each credit bureau produces a different style of report, Experian’s is the most user-friendly.
Credit bureaus are allowed (but not required) by law to report your negative information to potential creditors and others who want to know about you. The result of that can be devastating, all the way from unreasonably high interest rates to losing out on a great apartment or job to being turned down for insurance coverage.
While it might feel like those ugly blemishes will remain forever, they cannot. The law provides for specific time limits.
Bankruptcies. Up to ten years from the date of the last activity on the bankruptcy filing. Bankruptcy is the single worst thing you can do to your report.
Past-due accounts, charge-offs, collections, tax liens, judgments, and lawsuits. Up to seven years from the date of entry even if the damage is reversed or the account is brought current and/or paid off, which should also appear on the report.
Inquiries. Up to two years from the date of inquiry.
Exception. All negative information, including bankruptcies, lawsuits, paid tax liens, accounts sent for collection, and criminal records, will show up indefinitely in the future under these conditions: when you apply for $150,000 or more of credit or insurance or if you apply for a job with an annual income of at least $75,000 and your potential employer pulls a credit report.
Credit Scores
Fair Isaac Corporation tightly controls the technology that weighs different factors found in a person’s credit report. The result is a three-digit number known as your credit score. In the same way you have dozens or more credit reports out there somewhere, you have many credit scores as well. The FICO score, which ranges from 300 to 850, is the one that most lenders use and the one you should care about. It tells a lender, landlord, or insurer the statistical chances he has of getting repaid should he choose to do business with you.
Fair Isaac licenses its highly secret technology to the CRAs, who then add their own programs and statistical data to produce customized credit scores under names such as Beacon, Empirica, and Scorecard. While credit scoring is not regulated or standardized, one thing everyone agrees on is that the higher the score, the lower the lender’s risk.
It is difficult to say what’s a good or bad score since CRAs have different criteria and lenders have different standards for how much risk they will accept. A credit score that one lender considers satisfactory may be regarded as unsatisfactory by other lenders for comparable situations.
A credit score is like taking a snapshot at a moment in time. Once the shutter clicks, that exact picture cannot be duplicated. Your credit score is calculated by taking a snapshot of your credit history plus all contributing factors at a single moment. It does not reflect an average, nor will it be the same tomorrow. Your credit score is a fluid number—it’s always fluctuating. When a score is requested, the computer determines the score, reports it, and then forgets it. You could request your score from all three CRAs and MyFico.com on the same day, get four different scores, repeat the process tomorrow, and get another set of scores that could be altogether different.
Why You Should Care
Credit scoring is no longer just for determining what interest rate you will pay on your car loan. It is seeping into many areas of life. Insurance companies use it to determine risk and set premiums, landlords use credit scores to evaluate potential tenants, and employers use credit scores in the application process as a character reference.
A credit score to some people shows the way you take care of important things in your life. The problem is that people with bad or even mediocre scores wind up paying disproportionately higher and even burdensome rates.
Contributing Factors
Fair Isaac technology considers many factors when determining a credit score, some of which are kept secret. These are the fifteen factors they’ve disclosed:
1. payment history
2. amounts owed
3. length of credit history
4. pattern of credit use
5. types of credit in use
6. utilization rate
7. how long at current address
8. debt-to-income ratio
9. late payments
10. income
11. age
12. occupation
13. type of residence
14. how long you’ve had the same phone number
15. recent inquiries
Utilization Rate
Expressed as a percentage, this is the ratio between your available credit and the amount of that credit that you are using at any given moment. For example, if your credit limit is $2,500 and you have an outstanding balance of $250, you are using 10 percent of your available credit. In this case, your utilization rate would be 10 percent. In the world of credit scoring, the lower the utilization rate, the better. Generally, to maintain a good credit score, one’s utilization rate should never be higher than 30 percent.
Reason Codes
Credit scores come with reason codes for why the score was not higher. Reason codes vary from one CRA to another, but these appear to be the most common:
• Your credit card balances are too close to the limit.
• You have too many accounts.
• You don’t have enough accounts.
• Your accounts are too new.
• You don’t have a “healthy mix” of accounts.
• You’ve had too many inquiries.
• You are unstable.
How to Get Your Score
Every CRA has its unique score to sell to you. Remember, you can get free copies of your credit report every twelve months, but not your credit score. You must pay for that. As I said earlier, most lenders who will be considering your score use the FICO score issued by the Fair Isaac Corporation. Therefore, if you are going to check your credit score, I suggest you check FICO because it is the one most widely accepted and respected. Simply go to MyFico.com to obtain a copy of your credit score.
Every adult has his or her own score. Potential lenders will average the scores of a married couple applying for credit.
What You Can Do to Improve Your Score
If you have a low score, you should take a look at your credit report to make sure it contains no erroneous negative information. If the information is negative but true, unfortunately, you will just have to ride it out. From here on out, make certain you pay your bills on time, stop applying for new credit, and pay down the credit you have.
Don’t go crazy trying to get a perfect score. If you can stay around 760, you will be just fine.
Credit Repair
You cannot change the information in your credit report if it is true. However, if there are errors, you have every right to correct them. I would not recommend that you hire a service to do this. Credit repair companies are notorious for being shady at best. This is something you can do yourself.
The first step in repairing your credit report is to know exactly what’s in it. Don’t assume everything in it is correct. Nearly 70 percent of all credit reports contain some piece of information that is incorrect, obsolete, or no longer verifiable. Federal law gives you the right to challenge that information, no matter how serious or minor, through a process called disputing.
It is very important that you follow these strict guidelines when disputing any item in your credit report:
1. Make a detailed list of the items you believe to be false, inaccurate, incomplete, or obsolete.
2. Complete a request for reinvestigation dispute form and return it to the CRA that issued the report.
3. If you do not receive a response within six weeks, send a follow-up letter.
4. Keep excellent records and a good paper trail.
If after review you cannot prevail in having the item removed from your credit report, you have the right to submit your side of the story, provided it does not exceed one hundred words. This explanation will stay on your credit report until you ask for it to be removed. Anyone having access to your report will be able to read it.
How important could a one-hundred-word explanation be to a potential employer, mortgage lender, or landlord? It’s impossible to know for sure, but it can’t hurt.
Credit Counseling
Credit counseling is a service that helps people in serious financial peril avoid bankruptcy. Credit counseling is not charity; it is an industry.
Reputable credit counseling firms are nonprofit organizations, a designation that can be confusing. “Nonprofit” does not mean the company is run by volunteers and is not allowed to make money. On the contrary, nonprofit organizations can operate very much like a for-profit corporation. They can charge for their services and build up millions of dollars in cash reserves. They can pay handsome salaries, and their executives can drive fancy company cars and operate out of luxurious offices. They can advertise and participate in slick marketing campaigns.
Credit counseling is intervention in the form of confidential counseling and negotiation with the client’s creditors in an attempt to freeze penalties, reduce interest, and create a monthly debt repayment plan that is mutually beneficial to all involved.
Counseling can also include help with rent and mortgage issues, transportation needs, student loans, and bill paying. Some counseling organizations offer educational programs to help their clients learn how to manage their money well, live within their means, and embark on the road to financial recovery with an excellent chance for success.
Creditor-approved repayment plans are administered through the counselor’s debt-management program (DMP). While enrolled in the DMP, the client makes a single payment each month to the counseling organization, which then distributes payments to each of the creditors.
Credit counseling is a severe remedy. It is not the right choice for everyone. Effective as it can be, credit counseling is not a clever way to reduce high interest rates. Think of credit counseling as chemotherapy—it offers an excellent chance for recovery but is certainly not a treatment you would choose if you had any other choice.
To consider credit counseling, you need to be experiencing some or all of the following: You have past-due bills, you cannot make the minimum payments on your credit card accounts, you are borrowing from one card to pay another card, you are using credit for necessities such as groceries and gasoline, you have a damaged credit report, creditors are calling, and you have an overall feeling of despair.
Credit counseling itself typically won’t hurt your FICO score, the one most used by lenders. The scoring model sees any mention of “counseling” as a neutral entry. It neither hurts nor helps your score. However, the way a potential lender, landlord, or insurer sees credit counseling as it relates to the risk they may take with you cannot be predicted.
You can get an excellent overview of what credit counseling is all about by visiting the website of the National Foundation for Credit Counseling (NFCC) at NFCC.org.
Debt Negotiation
Debt negotiation involves cutting a deal with a creditor to make a one-time cash payment that is considerably less than the amount owed.
Debt negotiation is not a regulated profession, so there are no rules. Anyone can call himself a debt negotiator. Most debt negotiators require their clients to deposit huge sums into their equally unregulated company “trust accounts” before negotiations can commence. There are no guarantees. And the horror stories I’ve heard from well-meaning people who thought they could beat their debts would break your heart.
If by some stroke of luck you can negotiate with a creditor to accept less than the principal balance in exchange for calling the debt forgiven, don’t think it’s over for you yet. The law requires that creditor to report the amount you did not pay back to the IRS as ordinary income. You will owe taxes on it upon your next filing.
Debt negotiation is so problematic that it should be seen as a last resort, and only after you’ve given reputable credit counseling your very best effort.