Applying for Credit: Your Report and Score

capital

Assets are any items of value that you own, including cash, property, personal possessions, and investments. Your capital is the amount of your assets that exceed your liabilities, or the debts you owe. Lenders want to be sure that you have enough capital to pay back a loan. That way, if you lost your source of income, you could repay your loan from your savings or by selling some of your assets. A lender might ask: • What are your assets? • What are your liabilities?

credit bureau

A credit bureau is an agency that collects information on how promptly people and businesses pay their bills. The three major credit bureaus are Experian, TransUnion, and Equifax. Each of these bureaus maintains more than 200 million credit files on individuals, based on information they receive from lenders. Several thousand smaller credit bureaus also collect credit information about consumers. These firms make money by selling the information they collect to creditors who are considering loan applications. Credit bureaus get their information from banks, finance companies, stores, credit card companies, and other lenders. These sources regularly transmit information about the types of credit they extend to customers, the amounts and terms of the loans, and the customers' payment habits. Credit bureaus also collect some information from other sources, such as court records.

credit score

A credit score is a number that reflects the information in your credit report. The score summarizes your credit history and helps creditors predict how likely it is that you will repay a loan and make timely payments. Lenders use credit scores in deciding whether to grant you credit, what terms you are offered, or the interest rate you will pay on a loan. Information used to calculate your credit score usually includes the following: • The number and type of account you have (credit cards, auto loans, mortgages, etc.); • Whether you pay your bills on time; • How much of your available credit you are currently using; • Whether you have any collection actions against you; • The amount of your outstanding debt; and • The age of your accounts.

collateral

Creditors look at what kinds of property or savings you already have, because these can be offered as collateral to secure the loan. If you fail to repay the loan, the creditor may take whatever you pledged as collateral. A creditor might ask: • What assets do you have to secure the loan (such as a vehicle, your home, or furniture)? • Do you have any other valuable assets (such as bonds or savings)?

character

Creditors want to know your character —what kind of person they are lending money to. They want to know that you're trustworthy and stable. They may ask for personal or professional references, and they may check to see whether you have a history of trouble with the law. Some questions a lender might ask to determine your character are: • Have you used credit before? • How long have you lived at your present address? • How long have you held your current job?

Fair Credit Reporting Act

Fair and accurate credit reporting is vital to both creditors and consumers. In 1971 the U.S. Congress enacted the Fair Credit Reporting Act, which regulates the use of credit reports. This law requires the deletion of out-of-date information and gives consumers access to their files as well as the right to correct any misinformation that the files may include. The act also places limits on who can obtain your credit report.

redlining

The ECOA also covers applications for mortgages or home improvement loans. In particular, it bans discrimination against you based on the race or nationality of the people in the neighborhood where you live or want to buy your home, a practice called redlining.

Equal Credit Opportunity Act (ECOA)

The Equal Credit Opportunity Act (ECOA) gives all credit applicants the same basic rights. It states that race, nationality, age, sex, marital status, and certain other factors may not be used to discriminate against you in any part of a credit dealing.

Payment Reporting Builds Credit (PRBC) system

The Payment Reporting Builds Credit (PRBC) system will check on payment patterns and report to a creditor the history of payments that are typically not included on a traditional credit report.

debt payments-to-income ratio

The debt payments-to-income ratio is calculated by dividing your monthly debt payments (not including house payment, which is a long-term liability) by your net monthly income. Experts suggest that you spend no more than 20 percent of your net (after-tax) income on consumer credit payments. Thus, a person making $1,250 per month after taxes should spend no more than $250 on credit payments per month. The 20 percent is the maximum; however, 15 percent or less is much better. The 20 percent estimate is based on the average family, with average expenses; it does not take major emergencies into account. If you are just beginning to use credit, you should not consider yourself safe if you are spending 20 percent of your net income on credit payments.

debt-to-equity ratio

The debt-to-equity ratio is calculated by dividing your total liabilities by your net worth. In calculating this ratio, do not include the value of your home and the amount of its mortgage. If your debt-to-equity ratio is about 1—that is, if your consumer installment debt roughly equals your net worth (not including your home or the mortgage)—you have probably reached the upper limit of debt obligations. None of the above methods is perfect for everyone; the limits given are only guidelines. Only you, based on the money you earn, your obligations, and your financial plans for the future, can determine the exact amount of credit you need and can afford. You must be your own credit manager.

FICO

The information in your credit report is used to calculate your FICO credit score—a number generally between 350 and 850 that rates how risky a borrower is. The higher the score, the less risk you pose to creditors. Your FICO score is available from www.myfico.com for a fee. Free credit reports do not provide your credit score. According to Anthony Sprauve, senior consumer credit specialist at FICO, "The consequences of not maintaining a sound credit score can be very costly. A low score can bar you from getting a new loan, doom you to a higher interest rate and even cost you a new job or apartment."

credit report (credit file)

The record of your complete credit history is called your credit report, or credit file. Your credit records are collected and maintained by credit bureaus. Most lenders rely heavily on credit reports when they consider loan applications.

VantageScore

VantageScore is a new scoring technique, the first to be developed collaboratively by the three credit reporting companies. This model allows for a more predictive score for consumers, even for those with limited credit histories, reducing the need for creditors to manually review credit information. VantageScore features a common score range of 501-990 (higher scores represent lower likelihood of risk). A key benefit of VantageScore is that as long as the three major credit bureaus have the same information regarding your credit history, you will receive the same score from each of them. A different score alerts you that there are discrepancies in your report.

capacity

Your income and the debts you already have will affect your capacity —your ability to pay additional debts. If you already have a large amount of debt in proportion to your income, lenders probably won't extend more credit to you. Some questions a creditor may ask about your income and expenses are: • What is your job, and how much is your salary? • Do you have other sources of income? • What are your current debts?

conditions

General economic conditions , such as unemployment and recession, can affect your ability to repay a loan. The basic question focuses on security—of both your job and the firm that employs you. The information gathered from your application and the credit bureau establishes your credit rating. A credit rating is a measure of a person's ability and willingness to make credit payments on time. The factors that determine a person's credit rating are income, current debt, information about character, and how debts have been repaid in the past. If you always make your payments on time, you will probably have an excellent credit rating. If not, your credit rating will be poor, and a lender probably won't extend credit to you. A good credit rating is a valuable asset that you should protect. Creditors use different combinations of the five Cs to reach their decisions. Some creditors set unusually high standards, and others simply do not offer certain types of loans. Creditors also use various rating systems. Some rely strictly on their own instincts and experience. Others use a credit scoring or statistical system to predict whether an applicant is a good credit risk.