episode 1
Financial Education Training
Credit and Debt Management
History of Credit
Homeowner Education Program – Quarter 2
Welcome to the second series of our Financial Education training—introduction to Credit and
Debt Management. This training can provide you with the tools and information you need to
help build, or re-build good credit.
Our first episode explains how the credit reporting system works. We’ll discuss the history of
Credit, Credit Bureaus, Credit Reporting and Credit Scoring.
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Homeowner Education Program – Quarter 2
As you can see, credit is complex. Put simply, credit is when a person or company (the
creditor) extends you (the borrower) money or goods in agreement for payment later—usually
with interest and/or fees attached.
Credit used to be a personal system—the creditor and borrower knew each other, and the
creditor knew how likely the borrower was to pay back a loan based on the borrower’s
reputation.
Today, creditors rely on facts and numbers to figure out your reputation. Lenders want to know
the “4 C’s of Credit”:
• Capacity — whether you have enough income to pay back the debt
• Capital — how much you have available in liquid assets, such as savings
• Collateral — whether you have something invested in the loan that can be claimed if you
fail to pay, and
• Credit History (sometimes called Character) — if you have had credit before, and
whether you’ve been reliable with it
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Homeowner Education Program – Quarter 2
In today’s training, we’ll focus on Credit History, or the modern credit reporting system.
The credit reporting system assigns every borrower a score as a measure of credit character.
This credit score isn’t just used for extending credit—it can also be used to inform…
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Whether or not you get approved for an apartment
Your qualification for certain jobs
Rates you pay for insurance
How much of a deposit you have to pay for new phone, TV, or utility service
Because of the level and range of its influence, good credit can be one of your best long-term
assets—it’s well worth spending the time to understand and cultivate it.
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The 3 Bureaus
Homeowner Education Program – Quarter 2
So, now that you know what your score is used for, let’s look at who is doing the credit
scoring.
There are 3 main credit bureaus in the US that determine your credit score Equifax, Experian
and Transunion. These bureaus don’t issue credit at all—they simply collect information
from companies that have extended you credit. Then they compile that information to create
a comprehensive history of your credit behavior. A mathematical equation is then applied to
produce a three-digit credit score representing your borrowing history.
Each bureau tracks information independently, and issues you a unique score. In fact, your score
will usually be different across all three bureaus. Creditors can choose to report to one bureau or
to all three, so there can be slight variations from one bureau’s report to the next. A “tri-merge”
report refers to a combined version from all three bureaus, and will provide the most complete
information.
A little known fact is that creditors actually pay the credit bureaus to report your information.
Why? First, if each creditor reports your credit behavior, it helps all of them analyze risk better.
Second, creditors don’t want you getting new credit if you’re not paying an existing debt. By
reporting your payments as late, other creditors can avoid lending to you, making you more likely
to repay the debt you already owe.
When considering whether or not to extend you a credit line, companies rely on the credit
bureaus to provide your credit report and your credit score. Let’s take a closer look at the credit
report itself.
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The Credit Report
Homeowner Education Program – Quarter 2
Basic information
contained in your credit
report
• Identifying Information
• Tradelines
• Collections/Derogatory Items
• New Inquiries
A credit report is a detailed version of your credit history. Each report is formatted differently,
but they all contain the same basic information.
We’ll go through a full report later—but here’s a summary. First, you’ll find basic “Identifying
Information” such as your social security number, variations of your name, and any current or
previous addresses.
Then, you’ll find “Tradelines”—comprised of tradelines, which includes itemized information on
all of your credit accounts. However, some tradelines are set aside in separate sections, called
“Collections/Derogatory Items”. Here, you’ll find accounts that are past due, in collections, or
that were closed without being paid in full.
Finally, toward the end of your credit report, there will be a section for “New Inquiries”. This lists
the companies that have pulled your credit in the last 2 years.
Because most accounts continue to show up on your credit report for 7 years after they have
been closed, the report is a detailed and lengthy account of your credit history. However, many
companies don’t want to consider the full report to determine whether someone is a credit risk,
so they simply rely on a credit score.
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Homeowner Education Program – Quarter 2
What’s reported and
what’s not?
Mortgages, credit cards,
lines of credit, auto, student,
and small business loans are
all reported.
Rent, utilities, phone and
garbage are not reported
unless they become
delinquent.
Ever wonder what is, and isn’t reported to the credit bureaus?
Most people know the common sources: mortgages, credit cards, lines of credit, and auto,
student and small business loans are all reported. But many are surprised to learn that regular
monthly payments such as rent, utilities, phone and garbage service are not reported unless they
become delinquent. Paying these accounts on time won’t increase your score, but failing to do
so will decrease your score if they go into collections.
So, how do the bureaus determine your credit score?
Each bureau uses a slightly different formula, and the equations are proprietary—meaning the
bureaus don’t have to make them public. The most commonly used system was created by Fair
Isaac and Company or FICO—hence the term you’ve probably heard before, a ‘FICO score’.
Scoring systems affect everyone differently, and can sometimes be confusing. For example, in
the short term, if you start to clean up accounts that have led to bad credit, your score might
actually dip before it starts to improve. But in the long term, your score will generally reflect the
overall history and pattern of behavior contained in your credit report. Since you have three
different credit scores, lenders typically look at the ‘mid-score’ to determine whether you meet
their minimum score requirement.
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Homeowner Education Program – Quarter 2
Have you ever wondered what factors go into calculating your credit score?
Most people know that their score is affected by making their minimum payments on time every
month, but that’s actually just one of five main areas that determine your score.
• Payment history is the single biggest factor in your score, representing about 35% of
the total.
• Amount owed is the next factor, which accounts for 30%. Your score reflects both the total
amount that you owe and the ratio of what you owe compared to your credit available. If
you are using most of your available credit, you’re seen as a higher credit risk.
• Credit history rlength accounts for 15% of your score. Accounts that are open for a long
time and kept in good standing can contribute to a higher score.
• Types of Credit Used accounts for 10% of your score. Credit is usually categorized into 4
types—mortgages, installment accounts, revolving accounts, and other accounts—and it’s
generally better for your score to have a variety of account types, rather than just one.
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Homeowner Education Program – Quarter 2
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Homeowner Education Program – Quarter 2
Installment accounts
Account that have monthly
fixed payment towards original
borrowed amount.
Las cuentas renovables
Lines of credit that you can
charge against on an ongoing
basis.
Installment accounts are accounts where you have borrowed a single original amount, and you
have a fixed payment each month for a set timeline. Car loans and student loans are common
installment accounts. Revolving accounts are lines of credit that you can charge against on
an ongoing basis, such as credit cards, in which your balance and minimum payment will vary
according to what you charge, and the account can remain open indefinitely.
• The final 10% relates to new credit. Creditors get worried about new accounts (and even
new inquiries, which could lead to new accounts) because it means that you’re extending
yourself further—and could get into financial trouble. Generally, your score can be
negatively affected by too many new accounts or inquiries in a short period of time.
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Homeowner Education Program – Quarter 2
So now that you know the factors influencing your score, how can you increase it? There are
different strategies for each category.
For payment history, make at least the minimum payment, on time, every month. Although your
report reflects many years of history, the most recent 24 months are weighted the most heavily.
Building that current, positive history will gradually push out former payment issues.
For amount owed, try and keep your debt to less than 30% of your available total credit. For
example, if you have a credit card with a limit of $1000, it will help your score to keep the balance
to $300 or less. You might have to chip away at your existing debt to make it to the 30% mark,
but the most important part is to not incur NEW debt on these accounts. Also, if you’re thinking
about closing accounts, be aware that an account with a high available limit and a zero balance
works in your favor by keeping your debt ratio low. If you close the account, it will decrease your
overall available credit, and therefore increase your debt ratio, which may impact your score.
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Homeowner Education Program – Quarter 2
For length of credit history, keep long-term accounts open and in good standing. Try to
minimize how often you open and close new accounts or transfer debt from one account to
another—creditors like to see consistency over time. Again, when closing an account, think
about how long you’ve had it open, and consider how closing it will affect the average age of all
your accounts.
For New Credit — be conservative about opening new accounts, or even shopping around for
new accounts. A general rule of thumb is to keep the number of inquiries on your account at or
below 2 per year.
Finally, for Types of Credit Used — it’s best to have at least two different types of accounts in
your history, and a balanced mix whenever possible.
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What Does Your Score Mean?
Homeowner Education Program – Quarter 2
Now that you know your score and where it comes from, how does it stack up from a
lender’s perspective?
This chart illustrates how lenders view credit worthiness. Although there is some debate about
what the actual top score is, the range is 350 to 850. Any score over 760 is considered excellent.
If you have a score above 700, you should be able to qualify for most loan products, at the best
terms available.
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Homeowner Education Program – Quarter 2
If your credit score falls in the “good” category you may have to pay a slightly higher interest rate,
but you will likely still qualify for credit. Consider following some of the tips already discussed for
increasing your score, as small adjustments could bump you up into a higher category.
If your credit score falls below the good category, you’ll probably pay more in interest rates and
fees to obtain credit, and certain loan products may be unavailable until you restore your credit.
Keep in mind that while it’s a good idea to know your credit score, avoid over-emphasizing
the number itself. Some people check their score every month, and obsess about every small
change, but it’s really the credit history that your score represents that’s more important.
While it’s good to know some tactics to help improve your credit score, the bottom line is that
consistent, positive credit behavior leads to a good score. And while it is entirely possible to
recover from a negative event (or many negative events) in your credit history, there are also no
quick fixes.
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Homeowner Education Program – Quarter 2
Why quick ‘fixes’
don’t work:
When an item on your report
is disputed, the bureau has
30 days to investigate; during
this time that tradeline is
temporarily suspended, and
is not included in calculating
credit score.
Quick-fix companies take
advantage of the dispute
system by filing disputes
against every derogatory
item on your report and
pulling a new credit score
during the 30 day period.
We’ve all seen the companies that advertise they can ‘fix’ credit in just a few short weeks. Here’s
the story behind the scam: if there is an incorrect entry on your credit report, there is a way
to dispute the entry with the bureau. Upon request, the bureau has 30 days to investigate the
dispute; during the investigation, that tradeline is temporarily suspended, and is not included in
calculating credit scores. Once the investigation is complete, if the incorrect account entry is a
mistake, it will be removed. But if it’s legitimate, it will return to be included in your score. These
quick-fix scam companies take advantage of the dispute system: they charge you up-front, then
file disputes against every derogatory item on your report (whether it’s incorrect or not). While
the disputes are under investigation, they will pull a new credit score, which will look much higher
since all of the derogatory accounts are suspended, and tell you that they’ve fixed your credit.
The problem is, a month later, all of those tradelines re-appear, and your credit is the same as it
was before, only you’ll be out a lot of money.
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Homeowner Education Program – Quarter 2
We’ve reviewed all the components of credit and credit reports. Now let’s talk about where to
find your report.
When a potential creditor pulls a report or a score, they may be able to share it with you. If you
participate in a credit, financial, or housing counseling program, they may be able to pull a report
for you. There are also a lot of for-profit companies that will charge you for your report, score, or
for various credit monitoring services.
However, you can easily get a copy of your own credit report, for free. Federal law allows you to
request a free report every 12 months from each of the three bureaus. The bureaus created a
website called annualcreditreport.com where consumers may request free reports. You can
get all three at once, or if you want to check your report more than once a year, you can get one
at a time, in staggered months. While these free reports don’t include a credit score, you can get
a score for a fee, if you choose.
Be sure you use this exact website, because there are a lot of for-profit companies with
similar names.
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Homeowner Education Program – Quarter 2
When someone pulls a copy of your credit report, it is called either a “hard pull”, or a “soft pull”.
• A “Hard Pull” is used when you are applying for credit and your report is being used to
issue a credit determination. Hard pulls will show up as Inquiries on your credit report, and
can have a negative impact on your score.
• A “Soft Pull” is used for education or counseling, and while they may appear on
your report, they do not affect your score or count against your inquiry total. Going to
annualcreditreport.com is considered a soft pull.
If a company is pulling your credit report and you are worried about the effect on your credit, ask
them about what type of ‘pull’ it is.
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How to Read Your
Credit Report
Homeowner Education Program – Quarter 2
Reading Your Report:
• Identifying information.
• Summary of your report.
• Notes that may count against
you.
Public Records:
Bankruptcies, liens and
judgements filed against you.
Inquiries detail the companies
who have pulled your credit.
Tradelines:
• Company and account
number.
• Type of account.
• Date the account was opened.
• High loan amount or
credit limit.
• Current account balance.
• Current minimum monthly
payment.
• Payment History.
• Late payment occurance.
• Which bureau filed the report.
We’re about to walk through the process of reading a credit report. If you have your credit
report, keep it handy and reference it as during the next section.
A good place to start is with your Identifying information—much of it will be on the front page,
but some might also show up at the end.
Double checking these entries can help you spot potential problems with identity theft, or if your
credit has been mixed up with someone who has a similar name. If you see an address that was
never yours, or a variation of your name that you never use, that might represent an error.
Next, look for a summary of your report. This will typically include the total number and
combined balance of each account type, as well as your cumulative monthly minimum
payments. There will be a record of how many late payments you’ve had in the past, as well
as the number of public records on the account. It will typically include a summary of recent
inquiries, as well.
There will also be a section that gives you clues as to what might be counting against your score.
Sometimes these are obvious, like too many recent delinquencies, but can also be things like not
enough recent activity or short credit history. Everyone, even people with an 850 credit score,
have these notes, so it’s not necessarily something that needs to be fixed—just an indication of
some things the bureau took into account.
Information on Public Records and Inquiries will likely be near the end of the report.
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Homeowner Education Program – Quarter 2
Public records include items such as bankruptcies, liens and judgments filed against you. If
you have a public record, you will be able to see the type, where it was filed, the current status,
and—if it’s a joint credit report—which borrower was involved.
Inquiries detail the companies who have pulled your credit. In general, inquiries made by similar
companies within 30 days will only count against you once. For example, if you are shopping for
the best car loan, and three auto dealers pull your credit over a single weekend, those inquiries
will only ding your credit score once. Some reports also list separately those inquiries that did
not affect your score.
For most people, the bulk of their credit report is the trade lines section. Once you understand
how to read the trade lines, each entry should follow the same basic pattern. You should see:
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The Company and Account Number.
The Type of Account, such as mortgage, credit card or auto loan.
The date the account was opened.
What the original high loan amount was (in the case of installment accounts) or what the
credit limit is (in the case of revolving accounts).
• The current account balance.
• The current minimum/monthly payment.
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Homeowner Education Program – Quarter 2
• A Payment History section going back the past 24 months, but sometimes as much as 84
months.
• This section will have a series of codes that each refer to a specific payment note:
a 1 indicates on-time payments, 2 indicates 30 days late, 3 equals 60 days late, etc.
Sometimes a star designates on-time payment. Whatever the system, there will be a key
on the report, or provided by the company who pulled the report.
• There will be a section indicating how many times you‘ve been 30, 60, or 90+ days past due
on the account, as well as the current status of the account, such as “current”, “closed”, etc.
• Lastly, there will be an indication of which bureaus reported this trade line. Occasionally, if
they report the same account a slightly different way, it will look like you have a duplicate
entry on your report. Find the bureau names—there will likely be two bureaus on one of the
entries and one on the other—this doesn’t count against you in any way, it’s just a quirk of
the system.
If you are reviewing a joint credit report, your joint accounts will appear together, followed by
individual accounts under Borrower 1 and then individual accounts under Borrower 2.
So, now that you’ve got your credit report, what can you do with it?
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credits
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