All About Credit and Credit Scores

There is so much available information today about credit, credit score, accounts, types of credit, and much more. The amount of information can make it a little confusing exactly what you are reading since most of this info comes from the bureaus and they tend to keep the information they present relatively subdued in order for you to browse their sites to sift through endless words and phrases. Let’s make it simple and paint the correct picture of what credit is, how your scores are calculated, and why your credit is so important.

The History of the Credit System

Credit may seem like a relatively new system integrated into today’s society, however, credit has been around historically for centuries. Early credit reporting in the United States grew out of the 1800s, when credit was often based on a person’s reputation and word of mouth rather than documented records. Historically, this left more negative consequences than positive ones, as shopkeepers and merchants controlled who can get what and the rate they can get it at. Although documented in the 1800s, it is not hard to believe that systems comparable to this were used in even ancient times, during the Roman empire, Persian conquests, and even further back in time.

Today, there have been many changes to dated credit systems. Due to technological advances and more easily accessible information, the credit system today has been solidified and continues to make adjustments to improve it.

Credit Today

The credit system today has made tremendous strides in comparison to its historic applications. Today, credit is designed to show how well an individual is at paying back borrowed money, over a very long period of time. The better an individual is at paying back that money on time, the more “credible” and “creditworthy” the individual becomes. The more credible a person is, the more likely this person will be accredited with more lines of credit in the future at much easier to pay interest rates.

An individual’s payment history is documented by the creditors, who are the lenders, banks, or financial institutions that extend lines of credit over to individuals. These lines of credit are given by the creditors based on the applicant’s current credit standing. More often than not, creditors are not willing to work with individuals who have a low credit score or subpar credit report, because to them, that individual will be seen as a financial risk.

The reported payment history and activity of your account with a creditor are forwarded over to three nationwide bureaus:

• Experian

• Equifax

• TransUnion

These three major bureaus are responsible for displaying the history you have with a creditor on a report that is displayed. This is called your credit report and is used to showcase your payment history with any accounts opened under your name so that other creditors can inquire about your account history before extending you a line of credit.

The major bureaus are for-profit companies. Under the FCRA, they may provide your credit report only to businesses with a permissible purpose, such as a lender reviewing an application you submitted.

Your Credit Scores

Credit scores are probably the most talked-about subject on the internet. From ads on how to boost your credit score with Experian Boost, to the endless ads from Credit Karma and Credit Sesame to view your credit scores and see live changes. What often gets lost is that your score is only part of the picture when a lender decides whether to approve you.

This is not to say your score doesn’t matter, because it does. Many lines of credit available to apply and obtain due require a minimum credit score threshold to even be considered. But although you may be able to meet the minimum score, the main purpose creditors “inquire” about your credit report is to visually see the account statuses that have resulted in your score calculating the way it is.

Your credit score is only a reflection of everything being displayed on your credit report. Your credit report will be the final decision maker whether or not you will get approved for the line of credit you are attempting to obtain. Why is that you may ask? Let’s give an example.

Let’s say, you are relatively new to credit, have your first credit card, a car loan with 2 on-time payments under your name, and are added as an authorized user on one of your parent’s credit cards. Your scores may be extremely strong, maybe even in the 800s, which is great! The only problem is when applying for a home, your credit may look too new to truly gauge your creditworthiness. You may get denied even if you make enough money and even have a great credit score, but because you haven’t obtained additional lines of credit and can only showcase a very limited history of on-time payments. Regardless of your score, the banks will still see that as a risk on their end and will opt out of approving you a line of credit, especially ones the size of houses.

The Different Scoring Models

Many people check more than one credit app and get confused when the numbers don’t match. One app may show a decent score while another shows a noticeably lower one. Why is that?

Well, the answer is actually quite simple and is overlooked due to the shock of how low your score looks on Experian compared to Credit Karma. It is not because one score model is wrong and one is right. It is because you are looking at 2 completely different scoring models.

Free score apps are often called “inaccurate”, but usually they are simply showing a different model. Many free apps display a VantageScore, while many lenders use a version of FICO.

Different models weigh the same information differently, so the same report can produce different numbers. Which model a lender uses depends on the lender and the type of credit you are applying for.

It gets a little complicated from here so make sure you are seated and reread through this section a few times. FICO has released many scoring model versions over the years, and each is calculated from each of the three bureaus’ reports, so you can have many different FICO scores at once. This does not mean that your reports are different, every item on your report is still reflected regardless of the score or model being used.

VantageScore has also released several versions. Although there are plenty of models to choose from, it is solely dependent on which bank is inquiring about your credit through which bureau and the model they select to choose from. It does also depend on what line of credit you are trying to obtain, so don’t fixate on your credit scores, fixate on your credit reports and your account history.

Best Credit Monitoring Apps

With so many websites, apps, and credit reports to purchase from, which one should I go with? Here is what to look for.

Choose a service that shows reports from all three bureaus (Experian, Equifax, and TransUnion), refreshes them regularly, and alerts you to changes or potential fraud. Free apps can be useful, but be aware that some are funded by recommending credit products to you.

If you are preparing for a loan, consider a service that shows the FICO score versions lenders commonly use for that type of credit. Seeing the models side by side helps you understand where you stand before you apply.

Conclusion

There is an extensive amount of information available today about credit, how to fix bad credit, and even how to understand what goes into your credit. The most important thing to understand about your credit is your credit score is not the deciding factor of you getting approved or denied when applying for a line of credit. Your score is only a reflection of everything on your credit report. From payment history to the age of the accounts, to even the amount of accounts on your report, everything is taken into consideration before extending lines of credit. Make sure you know what is on your report before making any rash decisions to improve your credit scores. In some instances, your scores may be low due to negatively impacting items on your credit report. If that is the case, definitely look into disputing negative items on your own or hiring a reputable Credit Repair Company to bring your credit report and scores into a much stronger standing.