Most individuals and families use credit as a regular financial tool to manage expenses and facilitate major purchases. “Credit” broadly is a transaction between a lender or creditor and a consumer-borrower where the lender allows the consumer to make a purchase or borrow money and repay the debt over time.
Common examples of consumer credit transactions include mortgages, auto loans, student loans, credit cards, lines of credit, installment agreements and others.
Credit scores and credit reports
A consumer’s credit score or credit rating is a number based on their creditworthiness as evidenced by their past payment history and other factors. In other words, how risky is a credit transaction with the consumer? How likely are they to repay their obligation fully and on time?
The quality of a credit rating can make or break an application for a loan or other credit arrangement, or impact the interest rate or the size of a security deposit. It can also impact other important aspects of life. For example, a poor score could sink applications for insurance, employment, college admission, lease or security clearance.
Three national credit bureaus (Experian, TransUnion and Equifax) and a few smaller ones generate credit scores that lenders and creditors purchase to help determine the risks of extending credit to individuals. Consumer credit ratings called FICO scores range from 300 to 850 and are a snapshot of financial health at a given time.
Credit reports change for better or worse as the financial actions and condition of consumers evolve. The good news is that a person can influence their credit score through careful financial behavior.
Tips for more robust credit rating
Basic factors that influence credit scores include:
- On-time payments or (even better) those made even earlier in the credit cycle
- Frequency and number of credit applications (keep them infrequent)
- Ratio of total amount of debt to total amount of available, open credit
- Bankruptcy
- Judgments against the consumer
- Age of debt
- Delinquencies and their lateness
- Debts charged off for nonpayment or “bad debt”
- Full payment instead of the minimum, monthly payment (positive)
- Presence of older, open accounts with no balances (a plus)
Monitor and correct your credit reports
Consumers should regularly schedule reviews of their reports from the three credit bureaus and any smaller or regional ones generating scores. Check for errors in amounts, accounts open or closed, missed payments, delinquencies, bankruptcy, judgments, credit limits, dates and other details. Be sure delinquencies are not older than seven years and bankruptcies 10, after which they should have been removed.
Errors can be just that, usually resulting from mistakes of reporting lenders and creditors. Sometimes a consumer’s information is accidently merged with that of another person creating a nonsensical report. Or identity thieves can enter credit transactions under a stolen name with no plan to repay. (See link in last paragraph for tips on making report corrections and taking potential legal action for related losses.)
Handle credit with attention and careful planning
Parents of teens and young adults can provide information and counseling to their children about how to establish good financial practices that will protect their future ability to get credit. For example, it can be easy to fall prey to aggressive credit-card offers as a college student spreading their wings as adults without parental oversight. It does not take long to fall behind on credit-card payments and get over their heads in debt – but this can catch up with them when they graduate and want to buy a home or vehicle with credit.
But even if this happens, credit scores can be repaired over time, whether those of young adults or older people. Its never too late or too dire to begin healthy credit practices that will make a difference in future creditworthiness. Recent financial activity impacts credit scores more than actions in the past.