Credit history

From Wikipedia, the free encyclopedia

This article deals with the general concept of the term credit history. For detailed information about the same topic in the United States, see Credit score (United States).

Credit history or credit report is, in many countries, a record of an individual's or company's past borrowing and repaying, including information about late payments and bankruptcy. The term "credit reputation" can either be used synonymous to credit history or to credit score.

In the U.S., when a customer fills out an application for credit from a bank, store or credit card company, their information is forwarded to a credit bureau. The credit bureau matches the name, address and other identifying information on the credit applicant with information retained by the bureau in its files.

This information is used by lenders such as credit card companies to determine an individual's credit worthiness; that is, determining an individual's willingness to repay a debt. The willingness to repay a debt is indicated by how timely past payments have been made to other lenders. Lenders like to see consumer debt obligations paid on a monthly basis.

The other factor in determining whether a lender will provide a consumer credit or a loan is dependent on income. The higher the income, all other things being equal, the more credit the consumer can access. However, lenders make credit granting decisions based on both ability to repay a debt (income) and willingness (the credit report) as indicated in the past payment history.

These factors help lenders determine whether to extend credit, and on what terms. With the adoption of risk-based pricing on almost all lending in the financial services industry, this report has become even more important since it is usually the sole element used to choose the annual percentage rate (APR), grace period and other contractual obligations of the credit card or loan..


Contents

[edit] How credit rating is determined

Credit ratings are determined differently in each country, but the factors are similar, and may include:

  • Payment record - a record of bills being overdue, generally being more than 30 days, will lower the credit rating.
  • Control of debt - Lenders want to see that borrowers are not living beyond their means. Experts estimate that non-mortgage credit payments each month should not exceed more than 15 percent of the borrower's after tax income.[citation needed]
  • Signs of responsibility and stability - Lenders perceive things such as longevity in the borrower's home and job (at least two years) as signs of stability. Fact|date=May 2008}}
  • Re-Aging - Through re-aging, a credit history is re-written and you are given a fresh start on that particular account. This can dramatically improve the credit score. In 2000 the Federal Financial Institutions Examination Council (FFEIC) clarified guidelines on re-aging accounts for delinquent borrowers. [1] (PDF)
  • Credit outstanding--Lenders don't like to see the amount of credit owed bumping up against the credit limit of a card. Generally, a good idea is to owe no more than one-third of your total credit limit on a credit card.
  • Credit inquiries – An inquiry is a notation on a credit history file. There are several kinds of notations that may or may not have an adverse effect on the credit score. Soft pulls don't affect the credit score and are characteristic of the following examples:

A credit bureau may sell a person's contact information to an advertiser wanting to offer credit cards, loans and insurance based on certain criteria that the lender has established. A creditor also checks a person's credit periodically. Or, a credit counseling agency, with the client's permission, can obtain a client's credit report with no adverse action. Each of the preceding examples are commonly referred to as a "soft" credit pull.

However "hard" credit inquiries are made by lenders when consumers are seeking credit or a loan. Lenders, when granted a permissible purpose, as defined by the Fair Credit Reporting Act, can check a credit history for the purposes of extending credit to a consumer. Hard inquiries from lenders directly affect the borrower's credit score. Keeping credit inquiries to a minimum can help a person's credit rating. A lender may perceive many inquiries over a short period of time on a person's report as a signal that the person is in financial difficulty and is looking for loans and will possibly consider that person a poor credit risk.

  • Credit cards that are not used - Although it is believed that having too many credit cards can have an adverse effect on a credit score, closing these lines of credit will not improve your score. The credit rating formula looks at the difference between the amount of credit a person has and the amount being used, so closing one or more accounts will reduce your total available credit. And the lower the percentage of available credit, the more the credit score will drop. The credit formula also factors in the length of time credit accounts have been open, so closing an account with several years of history is another avoidable credit mistake.


[edit] Understanding credit reports and scores

The Government of Canada offers a free publication called Understanding Your Credit Report and Credit Score. This publication provides sample credit report and credit score documents with explanations of the notations and codes that are used. It also contains general information on how to build or improve credit history, and how to check for signs that identity theft has occurred. The publication is available online at http://www.fcac.gc.ca, the site of the Financial Consumer Agency of Canada. Paper copies can also be ordered at no charge for residents of Canada.

[edit] International issues

Credit history is typically local to one country. Even within the same credit card network information is not shared for different countries. For example, a person who has been using Visa credit cards issued by banks in China or Canada for many years who moves to the United States and immediately applies for a Visa will not be approved because of lack of credit history.

An immigrant must establish a credit history from scratch in the new country, which can take years. New immigrants are forced to seek loans from irregular channels, which can create social problems.




[edit] Adverse Credit

Adverse credit history, also called sub-prime credit history, non-status credit history, impaired credit history, poor credit history, and bad credit history, is a negative credit rating.

A negative credit rating is often considered undesirable to lenders and other extenders of credit for the purposes of loaning money or capital.

In the U.S., a consumer's credit history is compiled by credit rating agencies, more commonly referred to as consumer reporting agencies or credit bureaus. The data reported to these agencies is primarily provided to them by creditors and includes detailed records of the relationship a person has with the lender. Detailed account information, including payment history, credit limits, high and low balances, and any aggressive actions taken to recover overdue debts, are all reported regularly (usually monthly). This information is reviewed by a lender to determine whether to approve a loan and on what terms.

As credit became more popular, it became more difficult for lenders to evaluate and approve credit card and loan applications in a timely and efficient manner. To address this issue, credit scoring was adopted.[citation needed]

Credit scoring is the process of using a proprietary mathematical algorithm to create a numerical value that discribes an applicants overall creditworthiness. Scores, frequently based on numbers (ranging from 300-850 for consumers in the United States), statistically analyze a credit history, in comparison to other debtors, and gauge the magnitude of financial risk. Since lending money to a person or company is a risk, credit scoring offers a standardized way for lenders to assess that risk rapidly and "without prejudice."[citation needed] All credit bureaus also offer credit scoring as a supplemental service.

Credit scores assess the likelihood that a borrower will repay a loan or other credit obligation. The higher the score, the better the credit history and the higher the probability that the loan will be repaid on time. When creditors report an excessive number of late payments, or trouble with collecting payments, the score suffers. Similarly, when adverse judgments and collection agency activity are reported, the score decreases even more. Repeated delinquencies or public record entries can lower the score and trigger what is called a negative credit rating or adverse credit history.

When a lender requests a credit score, it can cause a small drop in the credit score.[1][2] That is because, as stated above, a number of inquiries over a relatively short period of time can indicate the consumer is in a financially difficult situation.

[edit] Consequences

The information in a credit report is sold by credit agencies to organizations that are considering whether to offer credit to individuals or companies. It is also available to other entities with a "permissible purpose", as defined by the Fair Credit Reporting Act. The consequence of a negative credit rating is typically a reduction in the likelihood that a lender will approve an application for credit under favorable terms, if at all. Interest rates on loans are significantly affected by credit history—the higher the credit rating, the lower the interest while the lower the credit rating, the higher the interest. The increased interest is used to offset the higher rate of default within the low credit rating group of individuals.

In the United States, in certain cases, insurance, housing, and employment can also be denied based on a negative credit rating.

Note that is not the credit reporting agencies that decide whether a credit history is "adverse." It is the individual lender or creditor which makes that decision, each lender has its own policy on what scores fall within their guidelines. The specific scores that fall within a lender's guidelines are most often NOT disclosed to the applicant due to competitive reasons trade secret. In the United States, a creditor is required to give the reasons for denying credit to an applicant immediately and must also provide the name and address of the credit reporting agency who provided data that was used to make the decision.

[edit] More than One Credit History Per Person

In some countries, people can have more than one credit history. For example, in Canada, although most Canadians are not aware of it, every person who applied for credit before obtaining a Social Insurance Number has two separate credit histories, one with SIN and one without SIN. This is due to the credit reporting structure in Canada. This can lead to two completely separate parallel histories, and often leads to inconsistencies (although typically the person in question will never notice the inconsistencies), because when a lender asks for someone's credit report with SIN, what the lender gets is different from what he would have gotten if he asked the report without providing the SIN. This is because, contrary to popular belief, when someone gets a new SIN for whatever reason, the two credit files are never merged unless the person requests specifically. As a result, a record with SIN zeroed out is kept separately from a record with SIN. Note this happens without the person even knowing it.

[edit] Credit Bureaus

Several credit reporting companies (vary by country):

[edit] References

  1. ^ Facts & Fallacies. Fair Isaac Corporation. Retrieved on 2007-08-08.
  2. ^ What’s In Your Score. Fair Isaac Corporation. Retrieved on 2007-08-08.

[edit] See also