As part of our credit series we have discussed the credit cycle and the concept of credit. In this article we will cover your credit profile and how the credit reporting system works. Credit is a highly personal matter because it is a reflection of you. Your credit profile does not make you a good or bad person, but it does make you a good or bad credit risk. It is a snapshot of your financial and personal integrity because offering credit is an expression of trust that you will repay your lender in a timely matter.
The credit profile is basically a two-part process, which includes the application and the credit report.
The application process allows the lender to assess the applicant’s character and ability to pay. On the application you are asked questions regarding your employment history and your addresses for the past three to five years. The answers to these questions provide a lender with information about your stability. Changing jobs often could signal to a lender that you may be less reliable than someone who stays in a job long-term. Your job history provides insights into your earning potential: how much you have earned, whether there has been a steady increase, and of course, the amount you are currently earning.
Your assets also yield insights into your ability to pay. Do you have assets or investments to repay the money borrowed? Do you own your own home? Nothing demonstrates stability more than home ownership.
Your debt load comes into play at this point. Are you overloaded with debt or can you handle more? How much you owe is very important. This can be assessed by your debt to income ratio which allows lenders to decide if you are a good risk or not. Often people have open credit cards with no balances on them. The lenders view this as an available credit line and even though there is no current balance, the availability is still there. This can raise your debt to income ratio. If you have credit cards that you do not use or ones with large available credit lines, either close them or lower the credit lines down to improve your standings. This will also keep you from the temptation of getting overextended.
The credit report defines the relationship that you have with your creditors and verifies the truthfulness of the application. It also presents your actions and attitudes towards credit or your creditworthiness, by listing the amount of credit that has been made available to you and detailing your borrowing and repaying habits. Each report contains personal information: name, address, birth date, social security number and employer information. The report also includes relevant court records, such as legal judgments, tax liens, bankruptcies, or overdue child support.
The credit history is also contained on the credit report and is a snapshot of your past actions. It shows how faithfully you have repaid other creditors and lists the loans and credit lines in your name from recent years. Reports vary from each of the credit bureaus, but generally they show the type of loan, the date you began the loan or opened the line of credit, the amount of the loan or credit limits, the balance owed and your payment pattern. The report may list, for example, the number of times you’ve paid late, including the times you were more than 30, 60, 90, days late.
The credit reporting bureaus are: Trans Union
PO Box 4000
Chester, PA 19022
PO Box 2002
Allen, TX 75013
PO Box 740241
Atlanta, GA 30374
In addition to the credit history, a list of who has inquired about your credit or has received a report within the past two years is provided by the credit reporting agencies. Often excessive inquires can be a red flag that you may be applying for additional credit. This could be interpreted that you have the potential for becoming overextended and therefore unable to repay the lender reviewing your report. So be cautious not to apply for credit in too many places within a short period of time.
If you have a negative credit situation on your report, you need to send a letter to the credit agencies explaining the situation you are in. This can help to assist a lender in determining your creditworthiness. This is the type of scenario where being proactive really pays off. Many lenders will charge a slightly higher rate for a period of time and lower their rate when you reestablish your payment history.
Lenders understand that a death, disability, divorce or other life event can mark your credit history, but good faith payments moving forward, a proactive approach and good communication will establish you once again as a good lending risk.
The Equal Credit Opportunity Act protects all consumers against decisions based on personal biases by restricting what bureaus can report. They can reveal court judgments since those could affect your ability to repay but are restricted on reporting race, religion, or criminal records.
In the end, your application is either approved or rejected based on the lender’s assessment of your creditworthiness. A rejection will not be reported or appear on a later credit report.
It is also helpful to seek the advice of a financial advisor who understands the credit reporting system and can work with you to resolve discrepancies in your credit report. In my next article we will discuss protecting yourself and the elements of the loan process and how they can affect your credit.