Let’s talk about the basics and when were done, you will have everything you need to start repairing credit. In order to get there, we want to make sure everyone understands what credit actually is – so we’re going to start with the easy stuff here on lesson #1. A little history lesson on the credit system and why credit is so important. We will break down the elements of what a credit report really is. We’ll talk about how credit scores are calculated and how debt impacts your credit. At the end, we will share some tips on how to optimize your scores. Then afterwards we will get into a more in depth lesson on repairing credit!
What is Credit?
So, what exactly is “Credit”? The real definition of “Credit” is: Confidence in a purchaser’s ability and intention to pay, and entrusting the buyer with goods or services without immediate payment.
In order to track all of this data, companies use credit reporting systems and credit reports. Companies use these systems and reports to decide whether or not to give you credit or a loan and how much interest their going to charge you for it. Your credit report is based on bills you have paid, missed or been late paying, loans that you have paid off, plus your current amount of debt.
A credit report contains information on where you work and live, how you pay your bills, and whether you’ve been sued, or filed for bankruptcy. Credit Reporting Agencies also called “Credit Bureaus” gather this information and sell it to creditors, employers, insurers, and they even sell it back to you (the consumer) in the form of credit reports and credit scores.
Credit reporting began more than 100 years ago. There is some dispute about who started it, and where, but the approach was basically the same. In the late 1800’s and early 1900’s several individuals in different cities began going from merchant to merchant taking notes about the people with whom they had credit arrangements. Those notes could say anything from, “He’s a reliable customer and always repays the debt,” to “He won’t pay, but his father will cover what he owes.”
When a customer would ask for credit from a merchant, the merchant would call the local credit reporter who would share the information they had on file about the person. Over time, credit reporting became purely objective and came to include only account payment history. It also grew from a local business to a major national industry. In the late 1960’s, credit reporting became computerized, which made it possible to become truly national in scope. In 1970 the Fair Credit Reporting Act (FCRA) became the first law to govern consumer reporting, including credit reports.
The FCRA has been amended several times but remains the primary national law governing credit reporting. It specifies who can get a copy of your credit report, under what circumstances, and what the report can include. It also defines the responsibilities of credit reporting companies, and the responsibilities of businesses that choose to report information to credit reporting companies.
Most states also have laws that regulate credit reporting. The laws recognize that lenders need credit references to protect their businesses from losses and provide better services to their customers. By sharing credit payment information lenders are able to make better decisions and make credit available to more people and at a lower cost. And like no other reference service, consumers have full access to the information that is shared.
Why is Credit Important?
Your credit is your reputation, once you mess it up – it takes some time to rebuild it! Your credit impacts virtually every aspect of your life. (at least most people don’t have cash to purchase everything, it’s just the way it is) Your credit score is also a direct reflection of what risk you are and how much you’ll pay in interest. If you want a home or a car, CREDIT the first thing the bank will ask about.
If you are looking for a personal loan or a BUSINESS loan, same thing… “What’s your credit score?” Homeowners insurance, car insurance, even life insurance companies are now pulling your credit. Employers look at your credit, especially for jobs with any type of financial responsibility will want to see that you are financially responsible and your credit is the best way for them to determine that. Nearly every opportunity in life is affected by your credit. So in short, your credit is EXTREMELY important and impact everything!
Some interesting statistics regarding credit reporting.
- 79% of credit reports surveyed by US PIRG contained errors or mistakes?
- Over 61 million Americans have subprime credit scores – Between 350-649.
- Nearly 33 million Americans do not have enough credit to generate a credit score.
- 24 million Americans have no credit file.
Most consumers have no idea how to get a copy of their credit reports! Incredible when you think about how much your credit impacts your life.
Big 3 Bureaus
Let’s dive into the basics. There are 3 major credit bureaus and nearly a thousand smaller bureaus. Make no mistake, credit reporting is BIG business.
- TransUnion – is based in Chicago and provides service to approximately 45,000 businesses and approximately 500 million consumers worldwide. It is also the third-largest credit agency in the US.
- Equifax – was founded in 1899, and is the oldest of the three agencies. They gather and maintain information on over 400 million credit holders worldwide. Based in Atlanta, Georgia, Equifax is a global service provider with over 7,000 employees in 14 countries.
- Experian – is the largest of the 3, they are based in Ireland and employ over 17,000 employees. Their revenue last year was over 5 billion dollars!
Anatomy of a Credit Report
Even though there many different bureaus, all credit reports have the same basic structure and anatomy.
Personal Information – This includes your name, potential aliases, your Date of Birth, Social, Current Address, previous addresses and employment information.
Negative Accounts – are anything that wasn’t paid or paid late. These are items you DO NOT want on your report because they lower your credit score.
Positive Accounts – are any accounts that have been paid on time and are items you DO want!
Public Records – are typically court records such as judgments, liens, bankruptcies, child support and sometimes criminal histories.
Inquiries – are a record of anytime your credit report has been requested. There are several types of inquiries and each have different meanings. I will be explaining this in greater detail in a few minutes.
Consumer Statements – to me, are ludicrous. I say that because it is essentially an area on your credit report that allows you to place a 100 words or less explanation about something on your credit. From my experience, adding a consumer statement never helps. If anything it can make you look guilty for something a lender wouldn’t have even wondered about until you mention it.
Furnisher Contact Information – this includes the names, addresses and phone numbers of the companies that have reported information to the credit bureaus. This information is kept available to you, the consumer so you are able to contact anyone that has reported information about you.
Let’s talk about negative items and red flags.
High Balances – One of the most important aspects of your credit score is level of credit card debt, measured by credit utilization. Having high credit card balances (relative to your credit limit) increases your credit utilization and decreases your credit score.
Late Payments – Did you know that 35% of credit score is payment history. Being late on payments will hurt your credit score. Consumers often send a payment on time and late payments show up on credit reports because of clerical errors, mail delays or simply due to sheer incompetence. These late payments can cause severe damage to credit reports and cost consumers thousands of dollars in unnecessary interest.
Charge Offs – Sometimes you see the term “Charge-Off” on your credit report. This can be confusing to many people because it almost sounds like a debt that isn’t owed, but that is not the case at all! As an example: If you are late paying a credit card, after a few months (typically 3 or 4 months) the creditor begins to lose hope that you will ever pay the account. The reason is: Statistically speaking, you won’t! The longer you go without paying, the more likely it is that the account will never get paid. Creditors and lenders pay TAXES on your DEBT. That’s right, your debt is considered an ASSET in the government’s eyes and the lender will continue to pay these taxes until the debt is either paid or charged off! So, after about 90 to 120 days, creditors will typically report the debt as “un-collectible” to the credit bureaus and the government, which will allow the creditor to STOP paying taxes on the DEBT as an ASSET for the company. This does NOT mean you no longer owe the debt, It just means the creditor believes it to be un-collectible. At this point the creditor will typically either sell the debt to 3rd party debt collection agency, or in some cases lease the debt to a company to try to collect. Meanwhile, the account is on your credit as a NEGATIVE item called a charge-off.
Repossessions – If you are late paying on a car or boat, or any vehicle for that matter; it can get ugly. The creditor will usually sell the vehicle at auction for a fraction of what is owed, then sell the balance to a collection agency. You are then left owing the deficiency balance.
Bankruptcy – Bankruptcy will typically devastate your credit scores. Bankruptcy or insolvency is a legal status of a person or an organization that cannot repay the debts it owes to its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor (“involuntary bankruptcy”) in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by the debtor (a “voluntary bankruptcy” that is filed by the insolvent individual or organization). An involuntary bankruptcy petition may not be filed against an individual consumer debtor who is not engaged in business.
Judgments & Liens – When a judge or the government orders you to pay a debt or places a lien on you, it’s not a good sign to lenders.
Inquiries – When consumers apply for credit, they authorize those lenders to ask or “inquire” for a copy of their credit report from a credit bureau, and an inquiry appears on their credit report. Inquiries are often placed on credit reports by businesses that the consumer did not apply with. Multiple hard inquiries negatively affect your credit score. Not only will your credit score suffer a few points of damage for each inquiry, but you will appear credit-desperate and risky to lenders. The only inquiries that count toward a consumer’s credit score are the ones that result from applications for new credit. Inquiries impact credit scores for up to two years.
Foreclosures – Foreclosures have recently skyrocketed after the collapse of the subprime mortgage industry. Foreclosures are extremely negative and usually high dollar amounts considering its real estate.
Duplicates – Duplicate entries, or instances where a particular situation shows up more than one time, on consumers credit reports can make it look as though they have more debt or credit issues than they really do, which can negatively affect chances of getting a loan or having credit extended. Some of the most common duplicate, triplicate or quadruplicate entries are medical bills, student loans, utility bills that have been sold to multiple collection agencies and/or any other item that gets sold and resold.
Other factors that impact credit scores negatively:
Debt – The more debt you have, the higher credit risk lenders you are and the lower your score goes. Simple as that!
Not paying at all – Completely ignoring your bills is much worse than paying late. Each month you miss a credit card, auto loan, installment account or mortgage payment, you are one month closer to having the account charged off. Eventually, the creditor will consider the debt uncollectible and either sell or lease the debt to a 3rd party debt collector. We have seen thousands of instances where the original creditor continues to report the entire balance and an additional collection item appear in the collections section of consumer credit reports. This causes duplicates, triplicates and quadruplicates and excessive and incorrect balance amounts.
Having Accounts Sent a Collection Agency – Creditors often use third-party debt collectors to try to collect payment from you. Creditors might send your account to collections before or after charging it off. A collection status shows that the creditor gave up trying to get payment from you and hired someone else to do it.
Now that you know what can hurt your credit, let’s discuss what will help it! “These Positive Items will increase your scores!”
Low Balances – are obviously better then high balances. Keep this important piece of information in mind throughout your life. EVERY DOLLAR OF DEBT YOU OWE IS CONSIDERED A RISK FACTOR – THE MORE DEBT YOU OWE, THE MORE LIKELY IT IS THAT YOU WILL NOT REPAY IT – AND….. EVERY DOLLAR OF DEBT WILL HURT YOUR CREDIT.This is a catch 22 for most people because you need to borrow money to build credit, but borrowing money hurts your credit at the same time. There is an old saying that goes: Banks are only interested in borrowing money to people that don’t need it, and boy is that true!
On Time Payments are always going to be good. Doesn’t matter if it’s a credit card, home loan, auto loan, student loan or whatever… pay on time and it’s “positive factor” that will only help you build your credit.
Aged Accounts – The older your open accounts are (with a positive credit history) the more likely it is that you will continue to pay on time; therefore – Old open accounts are positive and will improve your credit score.
You always want “Accurate Information” – Not only accurate account info, but just as important your personal information must be correct! There are a few reasons for this:
Your name for example: If you have multiple aliases or misspelled first, middle or last names – lenders may consider you a higher risk because it may be a sign that you are not who you say you are and possibly an identity thief. Or, how about your employment information….. If you are applying for credit, insurance or a job … and your employment information is different then what is on your application, IT’S A RED FLAG. There are many other instances such as you address or social security number that need to be corrected.
Finally, let’s talk about diversifying your credit. Lenders like to see that you are able to handle paying different types of account. This means “mixing it up”. Having a “Mix” of Credit means that you have different types of accounts reporting to the credit bureaus. With that being said, if you only have installment loans, that could hinder your ability to get a home loan because your credit is not diversified. You would be much better off showing that you have experience paying installment and revolving accounts as well.
Calculating Credit Scores
So, what are credit scores and how are Credit Scores Calculated? Credit scores are basically adult financial GPA’s! Seriously though, your score is your “financial reputation” and banks, lenders, employers, insurance companies and others take your reputation seriously.
There are many different types of credit scores. Thousands of companies sell their own whitelabeled credit reports and most use their own scoring models, so the score you get from one place to the next will typically be different. Regardless, the scores are intended to help you gauge how good or bad your credit is, but more importantly it’s to help banks, lenders and other companies make complex, high-volume lending decisions.
Let’s discuss how scores are calculated.
The biggest chunk of your credit score is primarily Payment History – (This is approximately 35% of your total score) – Late or missed payments obviously lower your credit score. In general risk scoring systems look for negative events like charge offs, collections, late payments, repossessions, foreclosures, settlements, bankruptcies, liens, and judgments. Within this category credit scores consider the severity of the negative item, the age of the negative items and the prevalence of negative items. Newer is worse than older. More severe is worse than less severe. And, many are worse than few. Basically, not paying on time can devastate your credit scores.
Debt is a huge factor and accounts for roughly 30% of your score. Scoring models consider the amount and type of debt carried as reflected on your credit reports. There are three types of debt considered.
- Revolving Debt
- Installment Debt
- Open Debt
Let’s talk about each type of debt because it does matter…..
1) Revolving Debt – This is usually a credit card, retail card, merchandise or gas cards Basically if you use it, then pay it and can use it again – it’s considered revolving. The most important measurement from this category is called “Revolving Utilization” which is the relationship between the consumer’s aggregate credit card balances and available credit card limits, also called “open to buy.” This is expressed as a percentage and is calculated by dividing the aggregate credit card balances by the aggregate credit limits and multiplying the result by 100, thus yielding the utilization percentage. The higher that percentage the lower your score will likely be. This is why closing credit cards is generally not a good idea for someone trying to improve their credit scores. Closing one or more credit card accounts will reduce your total available credit limits and likely increase the utilization percentage unless the cardholder reduces their balances at the same pace.
2) Installment Debt – This is a debt where there is a fixed payment for a fixed period of time. An auto loan is a good example as you’re generally making the same payment for 36, 48, or 60 months. While installment debt is considered in credit scores, it’s not nearly as important as revolving and hold far less weight. Installment debt is generally secured by an asset like a car, home, or boat. Consumers will typically make a far greater effort on secured accounts to make their payments are on time, so their asset isn’t repossessed by the lender for non-payment.
3) Open Debt – This is the least common type of debt. This is a debt that must be paid in full each month. A good example is a credit card that you are required to “pay in full” every month. The American Express platinum, Gold and Green cards are common examples.
Your Credit History, also known as “Time on File” or “Credit File Age” accounts for 15% of your score. The reason why it impacts 15% of your scores is because lenders know that the older your credit is the more stable it is.
This “age” is determined two ways:
1) The age of your credit file and the average age of the accounts on your credit file. The age of your credit file is determined by the oldest account’s “date opened”, which sets the age of the credit file.
2) The average age is set by averaging the age of every account on the credit report, whether open or closed.
Account Diversity or also known as “Types of Credit Used” – This is approximately a 10% contribution to your credit score. Your credit score will benefit by having a diverse set of account types on your credit file. Having experience across multiple account types (installment, revolving, auto, mortgage, cards, etc.) is generally a good thing for your scores because you’re proving the ability to manage different account types.
The Search for New Credit – (Also known as Credit inquiries) – Each time your credit is pulled by anyone except for you, it has an impact on your creditworthiness and your scores. A soft inquiry is when you pull your own credit and it does not impact your score, however when someone else pulls your credit – its considered a hard inquiry and is visible to lenders and credit scoring models. Keeping inquiries to a minimum can help your credit rating. A lender may perceive many inquiries over a short period of time on your report as a signal that you are having financial difficulty, and may consider you a higher risk. New credit and inquiries are about 10% of your score.
- 35% – Payment History: Negative information.
- 30% – Debt: How much and what type?
- 15% – Length Of Credit History: This is how long you’ve had credit
- 10% – Credit Diversity: This is the different types of credit experience you’ve had
- 10% – Inquiries (hard): This is when a creditor checks your credit report
Keep in mind, there are many other types of credit scores, each one uses its own scoring model.
How Debt Impacts Credit
Debt is the single most important factor on your credit! If there is any piece of information you should remember, it would be this: EVERY DOLLAR OF DEBT YOU OWE IS CONSIDERED A RISK FACTOR – THE MORE DEBT YOU OWE, THE MORE LIKELY IT IS THAT YOU WILL NOT REPAY IT – AND….. EVERY DOLLAR OF DEBT WILL HURT YOUR CREDIT.
Different types of debt have different impacts on your score.
Revolving account balances hurt more – this is because they can be reused. Again, credit is a numbers game and everything is mathematical and statistical. Credit scoring models use complex mathematical algorithms that determine the likelihood of repayment which in turn determines the risk assessment. Ideally, keep zero balances on your revolving credit accounts. Installment and secured accounts on the other hand hurt less – these may include homes, vehicles or personal loans. As long as they are not revolving like CREDIT CARDS, they will have a lesser impact on your credit and credit score.
Optimizing Credit Scores
Here are a few tips to optimize and increase credit scores. Of course, you only want positive and accurate information on your reports. If you do not, your credit will suffer. If you have mistakes, inaccuracies or outdated information on your credit report, there is a way to fix much of it. If you have negative information on your report, obviously you should begin repairing it, but there are also ways to minimize the items even if you are not successful removing them.
First, make sure you have a good mix of accounts. You should have at least one installment loan and three revolving credit cards. But, make sure you keep your revolving balances low! Pay down your revolving accounts such as credit cards first, try to keep them either very low or at zero balances.
Remember, you have to play to score! If you do not use your revolving credit cards every few months, they may stop reporting. Credit card companies PAY to report your account information to the credit agencies. Accounts that are idle or show no activity will stop being reported. I recommend that you buy a small ticket item with each card about every 90 days to keep them reporting. So you can use your accounts BUT keep your balances as low as possible.
If you have been paying on time, most creditors are happy to increase your credit lines. Some of them do it automatically, some do not. Try calling each credit card company every 6 months or so and tell them that you would like them to increase your credit line.
Your oldest accounts are your most valuable when it comes to your credit scores. It’s important to keep them open. Even if there is a yearly or monthly fee, consider keeping them open because closing an old credit card could damage your score!
Another important tip is opening and maintaining new accounts that report to the credit bureaus is key to building a solid credit rating. There are many different types of accounts that you can be approved for even with a poor credit rating. Typically, you will pay a higher interest rate, higher fees or may have to secure the account with collateral such as money or assets in order to open accounts if your credit is less than perfect. Credit history accounts for about 35% of credit scores; therefore if you don’t have sufficient credit history you need to open new accounts and pay the price if you ever want to increase your score.
We covered a little bit about inquiries earlier and how they impact your credit. Each time you apply for credit, an inquiry will appear and can drag your credit score down a few points, so try not to apply for credit unless you are either trying to build credit or absolutely need something!
Lastly, make sure your personal information is accurate and up to date. This includes your name, address, previous addresses, social, date of birth and employment history. When lenders or potential employers pull your credit, they may check to make sure the information you placed on your application matches what the credit bureaus have on file. If not, they may consider you a risk because of it.
There is a technique that does work and not many people know about it and many of those that do, don’t really understand enough to make it work. I’m going to explain it in detail for you.
One of the fastest and easiest ways to add instant credit history is by piggybacking.
There are two different ways you can “Piggyback”
- Authorized User
- Joint Account Holder
Each has its advantages and disadvantages and I’ll explain what those are.
What is piggybacking and which method should I choose?
Piggybacking is a technique that allows you to inherit someone else’s credit history by being added to an account – typically a credit card.
It can season your credit and increase your credit scores.
When the general public caught on to this trick a few years ago, it spawned an entire industry to meet consumer demand. There are companies that you can pay to piggyback a complete strangers credit card account.
They call these companies “tradeline dealers” who pay cardholders to rent out spots on their cards, but only as authorized users. Some credit card companies allow 20 or more authorized users, so these tradeline dealers charge anywhere from a few hundred to thousands of dollars to rent these spots. The authorized user never gets an actual credit card, but the account will typically show up on their report.
Eventually the banks, lenders and credit scoring providers caught on and the scoring models shifted the weight of authorized users to minimize this practice. With that being said, authorized users on most cards do not carry much weight and have a much lesser impact unless the primary on the account is a family member or spouse of the authorized user.
* IMPORTANT: There are many companies that sell tradelines – STAY AWAY from them! Any person buying tradelines in an attempt to cheat or defraud a mortgage score may result in mortgage fraud which is a felony and could result in jail time! Do not buy, sell or partner with any tradeline dealer or broker. On the other hand, if you ask a family member to help you – that is completely legal.
Here is how “Piggybacking” works:
1st – Find someone you trust. This person must have a credit card account with a major bank in good standing with a low or preferably no balance. Also you want to choose an aged account – one that has a long history – the older the better. And finally the primary must be willing to add you to the account.
- I say in good standing because you don’t want to inherit a negative account, right?
- I said “preferably low or no balance” because if the account has high balance or is maxed out, it will only hurt your scores.
- Lastly, I mentioned you want an aged account – why? The older the account is, the longer the payment history is and that will help your credit the most.
2nd – Now your friend or family member calls the credit card company and requests to add you as an authorized user or joint account holder.
- The credit card companies are usually more than happy to add someone else to the account.
- So, should you choose “authorized user” or “joint account holder”? That depends on a few things. Just try to remember this:
- Credit scoring models will not place much weight on authorized users unless the primary is your spouse or family member.
- As an authorized user, you have zero liability. If the account ever falls behind, has late payments or the primary maxes the card out, you can have it removed from your credit just as easy as it was to add it. Just call the creditor and ask them, they will remove you and remove it from your credit.
Now, on the other hand – if you choose to be a joint account holder, you are permanently responsible for that credit card forever! It’s really important that you make sure that the primary account holder is a responsible person and intends on paying on time and keeping the balance low otherwise there is a good possibility that you will end up with problems. If the primary maxes out the account, is late, goes to collections, gets a judgment or files bankruptcy – you are equally responsible for it, just as if you cosigned. Unlike an authorized user, you cannot simply ask to be removed – it’s permanent. So be VERY careful.
3rd – Be sure you monitor your credit reports to make sure it gets reported to the credit reporting agencies. Provided you did everything correctly; this account should show up on your credit reports within 30-60 days.
- The next time a lender pulls your credit report it will recalculate all (3) credit scores and include the account as if it was yours.
- The entire payment history will appear on your credit report and will be calculated into their new scores.
- I’ve seen this technique work wonders to boost scores, but I have also seen it cause catastrophic problems not only with credit scores, but relationships with friends and family. My best advice would be to do your due diligence and be careful who you share accounts with.
End of Lesson 1
Please proceed to Lesson #2