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| Building a Credit History |
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You start laying the foundation of your credit history the first time you borrow.
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There's a vast - and constantly growing - amount of information about how consumers use
credit.
And you can be sure that when you apply for credit, whether it's as routine as asking for a new credit card or
as significant as applying for a mortgage,
potential creditors
will check out your credit history. |
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MAKING HISTORYThe three major national
credit bureaus - Equifax, Experian, and
TransUnion - collect two types of information about you. The first is how you use credit, from
how much you owe on car loans, mortgages, and credit cards to the timeliness of your monthly payments. There's
an incredible amount of data that falls into this category - about two billion items a month, which breaks down
to an average of 11 items per credit user.
Credit bureaus also store public information about you that might influence the way lenders
evaluate your creditworthiness. This can include anything from records of bankruptcies and foreclosures
to court judgments and divorce proceedings. But credit bureaus don't gather any personal information that isn't
directly credit-related, such as what you spend on rent or utilities, or anything you pay for in cash.
Credit bureaus make the information they've collected available - at a price - to creditors, banks,
potential employers, landlords, and others who have a legal right to evaluate you based on your use of credit. Most
information remains on your report for a number of years, and damaging details can continue to appear for up to seven years
even if the account is closed or inactive. Bankruptcies can stay on your report for up to ten years
unless the state where you live imposes a shorter limit.
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WHO'S KEEPING SCORE?Did you ever wonder why it takes a retail store
or an online credit card company just a minute or two to approve your application for credit? Did you know that
you may be quoted one interest rate on a car loan while the next person to apply is offered a higher - or lower -
rate? These kinds of things happen because credit decisions often come down to the
credit score, or
FICO score, you're assigned by the credit
bureau your potential creditor contacts.
All credit bureaus use a process called credit scoring, or credit modeling, to evaluate the
risk you pose to a potential
creditor. According to FICO, the firm that developed the software some bureaus use to do
the calculation, the score depends on five main criteria:
- Your payment history, and specifically whether you pay on time
- The total amount you owe
- The length of your credit history
- How often you apply for credit
- The types of credit you use
Creditworthy behavior in these categories works in your favor, while risky behavior
works against you. And while there are general standards for the way the criteria are applied, there are no
fixed rules. Credit bureaus aren't required to explain the way they arrived at your particular score. All they
are required to provide are up to four reasons for the score, which the lender must tell you if you ask why
your application was denied.
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WHAT'S THE SCORE?
When you get a FICO credit score, a high number is better. The top 20% of reports that
are evaluated get scores over 780, while the lowest 20% get scores under 620. Each lender sets its own standard
for what qualifies as an acceptable score, and determines the interest rate for which you qualify based
on your score. The best rates - in this case, the lowest rates go to applicants with the highest scores.
Applicants with low scores, sometimes called sub-prime borrowers, may be offered credit at higher rates if
they are not simply turned down.
Credit scoring has its advocates and its detractors. Those in favor say that, in addition
to the advantage of speed, lenders get a fairer picture of your creditworthiness with this statistical snapshot.
Critics argue that reducing all the information about you to a single score can provide a distorted picture. They
also say that a lender can find it easier to say no on the basis of what appears to be a value-neutral system.
WHAT THE LENDER KNOWS
Lenders may go beyond your credit score in evaluating your application. For example, they may
want to know the amount you earn, whether you've been at the same job for two years or more, and if you've lived
at the same address for a period of time. In addition, lenders may be more willing to grant you credit if you
already have banking or investment accounts with them. |
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