How Credit Reports are Scored

In today’s day and age of financing homes and consumer products; a lot has been said of how credit scores affect our lives and a lot of myths have been told about the all elusive perfect credit score. Before I begin on this subject, try to forget everything you know about it first, because from what I have heard from people in the past, I’m almost certain that everyone reading this has an idea on how credit scores are driven and how to repair credit, and I’m equally certain that you are wrong on most parts.



Don’t get me wrong. I didn’t know myself until recently of all the intricacies involved with someone’s credit. Having worked with credit reports in the past, I got an idea on how things are set up and had a few things right on the subject. But learning from someone in the actual credit reporting business certainly opened my eyes on the matter and I would like to share it with you so that maybe you can learn as well and learn how to avoid the pitfalls associated with things that can and do go wrong with things such as this.



FICO is short for Fair Isaac and Company who developed this system. These scoring systems are used by different “repositories” that report the credit scores. These companies are: (Equifax) Beacon®, (Experian formerly TRW) Experian/FICO and (TransUnion) Empirica®. They all factor in how someone’s credit is and report them to various companies that request them. These companies generally use three of the above to give you three separate scores and get a general idea of how your credit is.



What these scores represent isn’t so much as what kind of borrower you are (in a general sort of way), but more exactly these figures determine the likelihood that a borrower will get a 90 day late payment on ANY trade line within a 24 month period.



The people who figured this scoring out took into many, many considerations how they come up with this. I’m talking about mathematicians that will know more about numbers and statistics than you and I ever will. So, to try and put a number on somebody’s credit history and make it match the population is a pretty hard thing to do.



The numbers themselves range from about 300 to 850. You can, however, get a score higher than that, but in the case of mortgage reports that’s what it is, and I’ll explain how in a minute.



Now for the good part of explaining how these companies break down the scoring of someone’s credit by importance. The first thing you have to realize is that there are several categories someone’s credit can be broken into. These mathematicians had to start somewhere so they broke it down into approximately (don’t quote me on this) 10 categories. The categories are broken down into what the basic differences are in borrowers. One category will be for those who have relatively brand new credit, say a college kid. Another might have more established credit. It goes on and on up until you get to someone who has used their credit for say, thirty years. Don’t ask me how this gets broken down, I was only told that they do. There is also a category for people who have filed bankruptcy, and in the same category are people who have had liens or judgments filed against them by various agencies. Please remember this as I will revisit this later on by how some of the following break downs will affect certain borrowers more than others.



So, right off the bat people are placed in a category on how established they are as a borrower.



Without further adieu, here is the break down of the important information of how peoples’ credit is graded:



35% Payment History- This is something that most of us would think of as the most important. This includes late payments and payoffs. However, this is also broken down into about 3 sub-categories. These sub-categories are: Frequency, Severity, and Recency.

Frequency is self explanatory. It basically means how often late payments occur. Severity means the number of days late like 30, 60, 90, 120, etc. Recency means how recent these late payments have occurred. They break recency down even more: 0-6 months, 7-23 months, and then 24 months on. So, the longer you go out on a late payment, the better it will be if it happens again, meaning it won’t hurt your score as much. Here’s another way to put it; if you have just improved your credit after having gone less than six months, then get a late payment, that will hurt your credit more than if you went 23 months and got a late payment.



30% Balances- This is again broken down into a couple of sub-categories. The most important are combined balances of what you owe compared to what the credit limits are on those lines. In this instance we are talking about revolving credit like credit cards or lines of credit with a store. They put a number on how it can hurt your credit. You can go up to 50% on your total balances before it starts to affect your credit for the worse. So, if you have 4 open revolving credit lines for a total of $20,000 you can borrow, it would be wise to keep the total number below $10,000. If it goes over, then it will hurt your score. If it goes over 75%, then it will get even worse.



They then factor in balances on each individual line of credit. It works the same as above. Each line of credit should be below 50% of the limit. Go over 50% and that will hurt, 75% will hurt more.



An important thing to remember is that even one line over that amount will hurt your score. It’s better to have small balances on all open lines of credit then one large balance on one. So, if you have something like 4 credit cards, and only owe the maximum amount on one, but the others have no balances, you might want to spread the one with the high balance out to the other cards you have so that you will have less than 50% balances on ALL the cards. This will help by making your total balances less than 50% as well as making each individual card less than 50% thereby helping your score.



The number of revolving lines you have will affect your score as well. A good number to have is between 3 and 5. However, if you have more don’t go closing them just yet. Closing accounts doesn’t necessarily make your score better, because they also score these reports by the total number of accounts you have had in your life. So, closing it can hurt you, and it will count on your report anyway. Just leave them be.



15% Credit History- This explanation is from the beginning, but this one is the actual part that adjusts your score. And 15% of your report is factored on this. It’s how long you have had credit. If you are a relatively new borrower, then your credit won’t be as good as someone with the same types of credit as you with the same late payments who has been using credit for thirty years. Time is really the only thing that affects this score.



10% Type of Credit- This is dependent on the type of credit you have. The different kinds of credit are:



Installment Loans- These include mortgages, car loans, etc. These are not too significant on your report to have them. If you buy something on installment, unless you are late, this gets factored into your total amount of lines you have had as I mentioned in the balances section. I learned that a mortgage payment has no more importance on scoring than a car loan payment, because they are basically the same type of payment. I always thought that mortgage payments were more favorable in scoring, but I was wrong. However, keep in mind that banks don’t just look at a number on the report. They look at mortgage history as well and if they see a mortgage late payment, that can be bad for your future mortgage prospects.



Revolving Lines- These are one of the most factored of the types of loans you can have, only because people use them so much and have become a daily part of people’s lives. These are the one’s you have to keep an eye on.



Finance Company Installment- These are the worst types of credit to get and can hurt your score the most. These are for promotional types of purchases where the customer pays later. You know which ones I mean, buy it now, don’t pay any interest for a year, or any payments for 2 years. By using this type of credit, you are hurting your credit.



I need to explain two types of credit.

Equity Lines- Most of us know what these are. They are basically second mortgages on your home, but they are revolving lines of credit. Because most people use the full amount to fix up the house or for emergencies, they usually use the full amount. Because the mathematicians know this and that having a balance over 50% on a revolving line will hurt the score, they score this as if it were an installment loan, and so it won’t have as much impact. Beware however, that they only do this if the amount is rather large. If you have a smaller equity line, then it will be treated as a revolving line. Don’t ask me the amount that it switches, but it happens. Just try to get the most when applying for an equity line as it will have less of an impact on the report.



Full Balance Cards- You know which ones I mean. These are the cards that are not necessarily revolving lines, because they have to be paid off every month. Because these are different, they are scored a little differently. These are scored by the highest balance in the last 18 months. So, if you normally just charge $500/month on the card, then the score will hurt you because they look at it as if you charge the full balance. And you know now how full balances can hurt your score. However, if in the last 18 months, you had a charge of $1500, but after, you normally go back to charging $500, this can help by showing your balance at less than 50% (for 18 months anyway).



10% Inquiries- This I think is where most people get it wrong; including me. There are different types of inquiries. Some affect your score, some don’t. The scoring also gets determined by what group you are in as I mentioned at the beginning. If you are a relatively new borrower, the number of inquiries will hurt your score more than if you are someone who has had credit for a long time. This is where being in these groups I first mentioned can help or hurt you.



They look at inquiries in a 12 month span. Generally 5-7 inquiries are allowed in a 12 month period before it hurts your score. And depending what group you are in, it will affect it by about 5-15 points.



The different types of inquiries are:



General Inquiries- These are the ones that can hurt you the most because it’s when you apply for credit such as a card, or a store line of credit. Because it lasts over a 12 month span, look out for how many lines of credit you are applying for.



Consumer Inquiries- These are what you, the consumer, pulls up to look at your report. These do not change your score. So, when you look at your report, don’t worry about pulling the credit.



Promotional Inquiries- These are from stores, banks, etc. who look at your credit to see if you can qualify for a line of credit. These don’t affect your score either. You will be able to see who has looked at your credit if you pulled your own report, but still they do not change your score. It WILL change if you replied to these offers, because they have to do a full credit check and then that would count as a general inquiry.



Mortgage Inquiries- You know where these come from and also where most people get it wrong. These inquiries are also looked at over a 12 month period, BUT these affect you score in a different way. Because they know you will be shopping for a mortgage in a short period of time, your score will not change as long as it is within a 2 week period. So, if you go to 5 different banks in 2 days and they all look at your credit, it will only count as one inquiry. You get this cushion of 2 weeks, so technically, you can have a mortgage broker check your credit every 2 weeks (as long as it’s within the 2 week period) for a year and it would still only count as one inquiry. So, if a broker tells you to not have anyone pull your credit because it will affect your score, he probably thinks it will, but it won’t. This, of course is changing as well. They are making it so you will have a 45 day buffer to look at mortgage reports.



That’s it for how they break up the scoring, but there are a few things you should know so you won’t negatively affect your score, or even how you might be able to improve it a little.

Bankruptcy, Liens and Judgments



If you have the misfortune of filing bankruptcy or you get a lien filed against your house, or even have a judgment from someone like a utility company. You will be put into the last group I spoke of at the beginning of this. You will be starting from scratch after the initial filing. Some things that are looked at when trying to re-establish credit after you file:



Percentage of Trade Lines in bankruptcy- When bankruptcy is filed, not all of the credit has to be filed with that. If everything is put in bankruptcy, how will you improve your credit with nothing to work with? If you can, try to keep a few things out of it that you know you can pay down or off. That way you will have something on your credit.



Number of Inquiries- One way to hurt your credit even more after getting out of bankruptcy is to apply for more credit. Remember what I said about inquiries? For someone in bankruptcy, that will hurt them worse. That’s why it’s smart to try to keep a few things out of it so you will have a few lines of credit to work with. Only do this if you know you can pay these bills every month.



Post Performance- This should be pretty obvious. How you pay your credit after a bankruptcy is looked at even more closely. This is very important, so watch out because they are judged more harshly.



Now here are some ways to improve your score a bit. This is not everything, but at least this way you know you will be off to a good start if you have injured your credit.



Collections- If you have had a collection on your report, you should pay this off as soon as possible. If you have let the collection go a couple of years and then pay it off, this will hurt your score worse because the activity on this account will be shown as recent by paying it down and as I said at the beginning; Recency can affect you as well. So, try to pay these down as soon as possible if you owe this money. This is at least damage control for the future.



Also, if you can get a letter from the company that this is wrong, I suggest you do this. Because if you have a letter that shows this is wrong, that will then increase your score.





Improving your credit score-



1) One way to improve your score if you have a collection agency trying to get money out of you, is to talk to them and tell them that you will pay off the amount owed so they can make their money as long as they supply you with a letter as I mentioned above so you can show this to the reporting agencies and it should dramatically increase your score, because you will have a bad spot removed as if it never happened.



2) Another way to boost your score a bit is to make your monthly payment BEFORE the bill comes. Most people nowadays can look at their monthly statements on line. So, to boost it a bit, make an early payment before it’s due.



3) This one’s for people who have no credit whatsoever and want to get a good start on building it up. Even if you just get a card for yourself, it has to be open and updated for 6 months before you will start to score on the report. One thing you can do is to have someone with established credit put you on several accounts as an authorized user. This doesn’t mean that the person whose credit is being used has to let that person use the account, and it has to be someone they trust, like a family member. But by doing this, you will now have a score because it’s like you get instant credit with history, a balance, but WITHOUT an inquiry.



4) For divorced people looking to keep their credit clean after a divorce. Just because you have a divorce decree and are not liable for paying a credit line, don’t think it won’t show up on your credit. If that line does not get paid, you will still get hit.



In order to get your name off a revolving credit line from a divorce, the balance has to be at zero, and then it will be possible to do.



If damage has been done because the divorced partner has made late payments, you can still contact the reporting agency, show them the divorce decree and submit an explanation. This however will not improve the score at all. So, be careful when getting divorced.



These are just a few ways of course. I’m sure there are more ways to improve it, but I can’t have all the answers. I do however want to share a few additional thoughts on credit reports.



When pulling your report up, make sure that the social security number you type in is correct. A lot of times it happens where you might get someone else’s credit line because the number was typed in wrong. If this happens, it can be corrected, but always check the number at the beginning of the report.



One thing you may find is that one repository reports one of your lines of credit, but another one may not. Not all companies you have credit with will report to ALL the repositories. As I said in the beginning, there are quite a few repositories. So, just be aware of this fact that not all the repositories are reported to. If you need to make a correction, be aware that you will have to contact ALL the repositories if you want a completely clean slate on your credit.



That’s about it for how credit reports are graded. There’s much more information out there, but this should give you a good idea on what to look out for and how to maintain your credit. Sometimes it may be worth a call to a company to get a negative taken off a report. Or it could just be a matter of time to heal a wound that you might have gotten. Hopefully, with this, you will be more informed. Good Luck!