By Greg Spaulding, President of Credit Score Insider
Credit is one of the most commonly used yet least understood parts of our financial lives.
Most people do not pay much attention to their credit until they need it. They may be applying for a mortgage, financing a vehicle, renting a home, requesting a new credit card or attempting to handle an unexpected expense.
It is often only after an application is denied, an interest rate is higher than expected or a credit score suddenly drops that someone begins asking questions.
Unfortunately, that is also when many people discover that something in their credit profile needs attention.
Why Credit Matters
Credit can influence whether an application is approved, how much someone is permitted to borrow and the interest rate and terms offered by a lender. The difference between stronger and weaker credit can add up to thousands of dollars in additional interest and payments over time.
However, credit should never be confused with a person’s character or overall financial worth.
A credit score does not measure how hard someone works, how much money that person earns or how much is held in savings. A person can earn a substantial income and still have a poorly managed credit profile. Someone with a more moderate income can have excellent credit because of how their accounts have been established and managed.
A credit score is primarily a risk-assessment tool. It helps a lender evaluate the likelihood that a consumer will repay an obligation as agreed, based on the information appearing in that consumer’s credit file.
In other words, credit is not a reward for financial success. It reflects how certain financial obligations have been reported and managed.
Your Credit Report and Credit Score Are Not the Same
Many people use the terms “credit report” and “credit score” as if they mean the same thing. They do not.
Your credit report is the record of your credit activity. It may include your open and closed accounts, reported balances, credit limits, payment histories, collection accounts and inquiries from companies that have reviewed your credit.
Your credit score, however, is a numerical evaluation of information contained in that report at a particular point in time.
Think of your credit report as the information in a file and your credit score as the result of evaluating that information. If the information changes, the score may change. If a different scoring model using a different algorithm evaluates the same information, the resulting score may also be different.
This is why properly managing your credit requires more than simply watching a number. The credit score is the result. The information in your credit reports is what produces that result.
You Do Not Have Just One Credit Score
One of the biggest misconceptions about credit is that everyone has one score that follows them everywhere.
In reality, a consumer can have dozens of credit scores.
Credit files are maintained by the three nationwide credit bureaus: Equifax, Experian and TransUnion. While much of the information appearing on the three reports may be similar, the reports are not always identical.
A creditor may report to one bureau before reporting to another. Information may be reported differently across the bureaus, a creditor may choose not to report to all three, or reports may contain errors. As a result, a score calculated from one report may be different from a score calculated from another.
There are also different scoring companies, score versions and industry-specific scoring models. A mortgage lender may use a different score than an automobile lender, credit-card company or consumer credit-monitoring service.
This is why the score you see through a free monitoring service may not be the same score a lender reviews. That does not necessarily mean either score is inaccurate. The scores may have been calculated using different credit-bureau information, different scoring models or information reported on different dates.
Your credit score is best viewed as a snapshot of your credit profile at a particular moment—not as a permanent grade.
What Influences Your Credit Score?
Although there are many scoring models, several general areas commonly affect a credit score:
· Whether your accounts have been paid as agreed
· The balances reported on your revolving accounts
· The length of your credit history
· Recently opened accounts and applications for new credit
· The types of credit accounts you are managing
However, these factors do not affect every consumer in exactly the same way.
For example, a recent late payment may affect someone with an otherwise excellent payment history differently than someone whose reports already contain several delinquent accounts. A high credit-card balance may also have a different effect on a thin or developing credit file than it has on a long-established profile containing numerous well-managed accounts.
This is one of the reasons generic credit advice does not work equally well for everyone. Credit should be evaluated as a complete profile, based on what is actually being reported.
Start With the Information, Not the Score
Many consumers immediately focus on how to raise their scores without first reviewing the information behind those scores.
A better place to begin is with all three credit reports.
Review the reports for accounts you do not recognize, incorrect balances, inaccurate payment histories, duplicate accounts and personal information that does not belong to you. You should also look for activity that could indicate identity theft or the unauthorized use of your information.
Consumers have the right to dispute information they believe is inaccurate or incomplete. However, accurate negative information generally cannot be removed simply because it is unfavorable.
It is also important to understand that checking your own credit does not lower your score. When you review your own reports or scores, it is generally considered a soft inquiry. A soft inquiry does not affect your credit score. A hard inquiry generated when you apply for new credit may affect it.
Credit Should Be Managed Before It Is Needed
The worst time to discover a credit problem is after you have applied for an important loan.
Credit should be reviewed and managed proactively, just like a bank account, insurance policy or investment portfolio. That does not mean obsessing over every minor score fluctuation. Credit scores can move as balances and other information are updated.
Instead, proactive credit management means periodically reviewing the information in your reports, paying obligations as agreed, managing revolving balances responsibly and addressing possible inaccuracies before they interfere with an important financial objective.
The first step toward stronger credit is not searching for a trick, shortcut or guaranteed score increase. It is understanding what is being reported, what may be affecting your credit profile and what can realistically be improved.
Credit can be complicated, but it does not have to remain a mystery.
Greg Spaulding is a credit consultant and founder of Credit Score Insider, based in Agoura Hills, CA. He helps individuals and businesses navigate credit strategy and financial health. Contact Greg at www.creditscoreinsider.com, 888-726-7304 or Greg@creditscoreinsider.com.
