Untangling Your Credit Report
Are you getting credit card offers in the mail? Did you have to give a deposit in order to get a cell phone? 
By Esteve Coll-Larossa
Were you denied credit or are you paying high rates on your mortgage or car loan? If the answer is yes to any of these questions, the information contained on your credit report is playing a decisive role.
Understanding the components of your credit report is paramount for a healthy and prosperous financial life. Not only will finance companies be looking at your credit report when you apply for credit — but also potential employers, landlords, and unfortunately, criminals trying to steal your identity.
So,
let’s bring some clarity to this topic. First of all, what is a credit
report? Well, simply put, it is just a snapshot of your financial life
at a given point in time. The most important part of the credit report
is the score. Different credit agencies use different scoring models
and formulas to come up with the score. In general terms, we can say
that 35 percent of your score is based on your payment history; that
is, whether or not there are any late payments with the most recent
payment history being the most relevant.
Thirty percent
of the score is what is called capacity, which is basically the
difference between the limit on your credit card and the balance owed.
When your credit card is maxed out, your capacity will be low and so
will your score. The concept of length of credit takes about 15 percent
of the score. In other words, the older the account the better it is
for the score. The next 10 percent is determined by how fast the
consumer is accumulating debts in the last 12 to 18 months.
Every time that
a potential creditor pulls your credit report, an inquiry is placed on
your credit file. Each inquiry reduces the score by an average of five
points. Finally, the last 10 percent goes to the consumer’s mix of
debts. There are two ways to report credit: installment credit (think
of a car or personal loan) and revolving credit (your credit card for
instance). Unfortunately, there are no magic numbers, but the ratio of
revolving versus installment credit is critical.
Having said
that, it is relatively easy to realize what to do and what not to do in
order to improve your credit score. Obviously, late payments are bad.
They damage the score independently of the amount of the late payment.
It takes an average of 24 months to restore the score due to a late
payment.
Additionally, having your credit cards to the limit, applying
for credit excessively, and opening new credit accounts in a short
amount of time will also take a toll on your credit score. On the other
hand, a consumer’s debt ratio, salary, and length of employment or
residency at the same address have no effect on the score.
Just like it is
not difficult to hurt the credit score it is also not difficult to
improve it. There are a few things you can do to get on the right
track. To begin with, continue making payments on your credit cards,
and, even though this might sound counterintuitive, do not close your
credit cards. Do you remember our discussion about capacity and length
of credit? Be selective; keep open those credit cards with the highest
limits and oldest opening dates.
Also, try to
transfer revolving accounts to installment accounts. For example, if
you owe a balance on a credit card, which is a revolving credit
account, get a personal loan, which is an installment account, to
payoff that balance. Depending on the age of the credit card and what
limit you have, it would be advisable not to close it.
If you have any
doubts about the contents of your credit report you can request it free
of charge. As of September 1 2005, the Federal Fair Credit Reporting
Act requires the credit agencies in the country, Equifax
(1-800-685-1111), Experian (1-800-397-3742), and Transunion
(1-800-916-8800) to give you a free copy of your credit file once a
year should you request it. You can call
1-877-322-8228 or go online to www.annualcreditreport.com.
