The business of lending money entails a lot of risks hence the importance of the Credit Reporting Agencies. Financial institutions like banks and insurance companies take a lot of risk in lending to people for various purposes like acquisition of homes and vehicles, or payment of their children’s tuition.
These companies try to minimize the risks of extending loans by looking at the credit history of their prospective clients. Borrowers who have been found to have a good credit history are usually given low interest rates, while those with a poor credit history are subjected to high interest rates, if they get approved at all.
How Credit Reporting Agencies Work
But how do financial institutions know about the credit history of a borrower?
They approach credit reporting agencies, also called credit bureaus. These are companies that compile and maintain the credit history of all citizens in the country. If you have a credit card or have taken out a loan from any financial institution, then you have your credit history.
Credit reporting agencies collect and maintain the credit history of a borrower by gathering all your activity or involvement with financial institutions like banks, mortgage firms and credit card companies. These firms then create a comprehensive credit report which is the basis of a person’s credit score, a three-digit grade that can affect your financial plans.
Fair Credit Reporting
In the past, the credit history and credit score of borrowers were revealed only to financial institutions such as banks and credit card companies. Consumers back then had absolutely no idea of what their credit history and score was, and how these bits of information affect their financial viabilities. Everything changed in the 70’s with the enactment of the Fair Credit Reporting Act.
This law basically gave U.S. citizens the freedom to ask for a copy of their credit reports for free, and to receive a copy of the report with adverse findings if they are denied of a loan. Under the same law, you can also report errors on your credit report and have the credit bureau respond to your complaints in 30 days.
If it is proven that there are indeed errors in your credit history, the credit bureau is required to correct these issues within 30 days. On the other hand, if all the information on your credit history is correct and you have adverse credit findings, this information will be removed from your credit history after seven years.
The Fair Credit Reporting Act is one of the many laws passed during the 70s that protected and promoted the rights of consumers. Other laws that were also passed during that time include the Truth in Lending Act. The Truth in Lending Act basically shields you from unfair and untruthful billing processes employed by banks and other financial institutions.
The Big Three Credit Reporting Agencies and Credit Bureaus
In the United States, there are three credit reporting agencies — Equifax, Experian, and TransUnion. Collectively, they are referred to as the Big Three. The 3 credit bureaus, however, are not the only credit reporting agencies in the United States. There are also other smaller and industry-specific agencies that provide credit reports and similar risk management services.
The 3 credit bureaus are the most popular since they dominate the consumer credit information industry. For example, Experian has credit information of at least 66 per cent of the total U.S. population. This gives you an idea of how big the operation of the Big Three is.
The Big Three have two basic services. They gather and process credit information of all U.S. consumers. In gathering credit information, these companies receive monthly consumer credit information from all lending institutions in the U.S. The information may pertain to the total debt of individual consumers and their repayment history. Information like your monthly income and contact details are also sent to the credit bureaus.
Similarly, the Big Three also gather public records on financial information like court records regarding bankruptcies. Thanks to the Fair Credit Reporting Act, you can get all of these pieces of information by requesting for a copy of your credit history from any of the Big Three credit bureaus. Your request for information is called a soft inquiry, which pertains to all requests by consumers and employers.
Hard inquiry, on the other hand, pertains to requests by financial institutions. The Big Three are independent from each other, and thus collect information on your credit history in different ways. So a credit report from Experian is very different from one issued by TransUnion, in the same way that its report will differ slightly from the report of Equifax. Also not all lending institutions report to these credit bureaus which lead to more discrepancies.
Credit bureaus don’t just gather information about your credit history. These companies also process the details to come up with the credit score, a three-digit grade that can affect your ability to avail of the loan. The credit score ranges from a low of 300 to a high of 850. Basically, a low credit score prevents you from getting a loan, or subjects you to high interest rates. On the other hand, a high credit score gives you benefits most remarkably low interest rates.
If you have a high credit score, you can apply for a housing loan or auto loan and pay lower amortizations compared to another consumer with a low credit score. Think of a credit score as your grade in school. Credit rating agencies look into different variables in coming up with the credit score. These variables include your payment history, outstanding debt, length of time you have been part of the credit system, and your new credit.
Your payment history comprises the biggest bulk of your credit score at 35 per cent. Creditors would want to know your track record in paying off your loan obligations. If you are habitually late in paying your bills, or if you have bankruptcies before, then you can expect to have a very low score in your payment history. In turn, your credit score suffers.
The next component that credit bureaus look at in computing your credit score is your outstanding debt. The total amount that you owe all your creditors will be considered here by the credit bureau. Other components in calculating credit score include the length of time that you have been part of the credit system (15 per cent); your new credit (10 per cent) and the types of credit that have been extended to you (10 per cent).
How Credit Score Affects You
The credit score computed and reported by credit bureaus can have a huge impact on your life. Your plans like purchasing your own house or getting a new car may be derailed if you have a poor credit score. Banks and other financial institutions may still give you a car loan or a home acquisition loan, but chances are high that you’ll be subjected to high interest rates.
To cite an example, say you are applying for a vehicle loan. If your credit score is within 500 to 589 range, then a bank may give you an 18 per cent interest rate for 36 months. But if you have a credit score of 700 to 850, the interest rates may go as low as six per cent. Of course, there are other factors that may affect interest rates aside from your credit loan. These factors include your equity, the type of property that you are acquiring, and so on.
How to Improve My Credit Score at Credit Reporting Agencies
Now that you have learned how your credit score affects your quality of life, then you should also be aware of ways to improve your credit score. Financial advisers have many tips on improving credit score such as reviewing your credit history and correcting any errors. Studies have shown than 1 out of four U.S. consumers have incorrect information on their credit history, affecting their credit score in the process. You should also limit your use of credit cards. K
eep your total credit to 75 per cent or less of your total credit limit. If you can keep it to as low as 25 per cent, then the better. You must also make it a habit to pay your bills on time. As mentioned earlier, payment history comprises 35 per cent of your credit score. Prompt payment of your credit card bills will improve your payment history and positively affect your credit score.
Generally speaking, frequent inquiries on your credit report can negatively affect your credit score. So don’t inquire on your credit report unless you really need to. If you are interested in applying for a loan, it would be best to make multiple inquiries with banks first before requesting for your credit report. This way you can limit the inquiries on your credit history.
The bottom line is that Credit Reporting Agencies and credit bureaus have a significant impact on your life. So make sure that you are aware of your credit history and more importantly, if you have a less than stellar credit rating, you should learn the different ways to improve your credit score.