A few weeks ago, Jim called and asked about how his credit score worked, as he was in the middle of a mortgage refinance. Based on our conversation, I decided to share what I’ve learned over the years about credit and credit scores.

The challenge we face is that our credit score is used for everything from interest rates on mortgage and consumer loans, to pricing on auto insurance, to our ability to open deposit accounts, to name just a few. Understanding some of those credit elements can equip us to make better decisions, when it comes to use of credit.

Short History
With the rise of the availability of consumer credit and credit cards after WWII, lenders needed a way to evaluate the creditworthiness of borrowers, and the likelihood that they would pay their bills. In 1956, engineer Bill Fair and mathematician Earl Isaac started Fair, Isaac & Company, after meeting at Stanford Research Institute in Menlo Park, CA. FICO sold its first credit scoring system to lenders just two years after the company’s creation and debuted its first general-purpose FICO score in 1989. While there are several versions of the FICO score, scores are based on credit reports and scores range from 300 to 850, while industry-specific scores can range from 250 to 900.

Since that time, a number of other companies have developed credit risk-assessment tools, though FICO continues to dominate the market.

Credit Reporting
Each month, lenders with whom we each have credit, report loan statistics to credit reporting agencies. For many consumers, the common credit lines are credit cards, auto loans, and mortgage loans. The statistics which are reported typically include original loan balance, current loan balance, and payment history. For credit cards, the report includes maximum credit line and current balance.

Reporting Agencies
In the U.S., the three large credit reporting agencies are Equifax, Transunion, and Experian. These three organizations collect credit histories on consumers, and then sell that information to those who either wish to extend us credit, or to those from whom we have applied for credit. For a time, the three reporting agencies also sold their own credit scores. In addition, many large lenders, including the major credit card issuers, have developed their own proprietary scoring models.

Report Information
Your credit report contains more than just your credit history. It also contains information on any liens or judgments issued against you, your address history, your date of birth, and a (usually) masked version of your social security number. If you are a signer on a lease, which is common if you are an owner or officer of a business, those work addresses will also show up on your credit report.

Report Access
In 2003, Congress amended the Fair Credit Reporting Act (FCRA) which was passed in 1970 and amended in 1996. This amendment required that consumers have access to a free credit report at least annually. Therefore, the three large reporting agencies, working with the FTC, developed and continue to maintain, the website found at www.annualcreditreport.com. Through this portal, and only through this portal, you as consumer have access to one free annual credit report from each of the three large reporting agencies. Note that if you search for “free credit report”, there are any number of sites which pose as free access, specifically to separate you from your information and your money. So be aware.

Credit Impact
Our research indicates there are several items which impact your score. Those entries, which have a high impact on your credit score, include payment history, credit card use, meaning balance to available credit, and derogatory marks. The age of your credit matters, though it has medium impact. The number of total accounts and the number of hard inquiries have a relatively low impact on your credit score. Also, note that if you have a credit card in your name, though you use it exclusively for business, this balance and credit limit will be reported on your credit.

Hard inquiries? When you apply for credit, and the potential lender checks your credit score, this is called a hard inquiry. If a credit card company wants to send you a solicitation to apply for their card and wants to see if you are creditworthy before they make the offer, this is called a soft inquiry, and has no impact on your credit score.

The longer the age of your credit, the fewer your accounts, the more your payments are on time, and the lower your card balance compared to available credit, the better your score.

Credit Tracking
In addition to the referenced annual credit report, there are several websites that offer regularly updated credit scores. The most popular is Credit Karma. Note that, like much of “free” social media, there is no direct cost to use the site. Be advised though, that they have arrangements with any number of vendors to make their products available to you, which is how they make their money.

Example
Let’s say your car is aging and high mileage, and you need to replace it. You don’t have quite enough on hand to pay cash, so you need to finance a portion of the purchase price. Typically, once the loan is financed, your credit score will take a temporary hit. What happened? First, there was a hard inquiry. Second, there is new debt, which reduces the “average age” of your credit history. This is nothing to worry about, simply something to be aware of.

Summary And Action Items
What to do? Each year, go to www.annualcreditreport.com, and pull down a report from each of the three agencies. If information is inaccurate, work with the agencies to correct it. Consider tracking your score on a regular basis, using one of the free tools. This will give you insight, as you watch the trends, into those actions on your part which impact your score. We do not subscribe to any of the services which we would need to pay for, which purport to monitor or protect our credit.