Credit reports are used by lenders, employers, and companies to help them arrive at significant decisions when it comes to you, such as whether to lend you money or whether to hire you.
While some people have never heard of these reports, others have invested time and effort to correct potential mistakes in them. Be that as it may, in the end, everyone is affected by what those reports entail, including you, regardless of whether you are aware of it or not.
In this article, we will take a look at credit reports and the type and amount of data they contain. It’s important to be in the know here because an unfavorable report can have grave implications on your creditworthiness. Checking for false information in your credit report is very important, so we will share tips on when and how to fix it.
What is a credit report?
A credit report is a document that gives creditors an insight into the way credit applicants have managed any sort of debt in the past. The payment history of potential customers is probably the most important aspect of the report. However, a lot of other types of data are also compiled in it, so it includes things like active loans, the total debt a client is up against, the way they handle different credit products, or whether they have previously handled similar loans. Even things like paying bills on time count.
Lenders require this information to assess the risk of lending money to any particular person. They even tailor credit terms based on this data, so credit reports are the go-to summary that creditors check before approving your credit request (mortgage, car loan, personal loan, etc). A favorable credit report can bring you lower interest rates, a higher line of credit, and it can also affect the conditions of your current account.
Join us as we go over what a credit report entails and why it’s important for you.
What does a credit report contain?
Credit reports have four different sections: personal information, detailed info on your credit accounts, public records, and logs on inquiries.
Obviously, this section holds personally identifiable information because mistakes regarding identity can prove to be very costly when it comes to credit records. To ensure the credit history belongs to a particular customer, the report contains a name and a Social Security number, address, telephone number, driver’s license, and similar information including nicknames, changes of names, previous addresses, co-signers of previous loans, and so on.
This is the focal point of the report. It holds records on each account you have at the moment or any account you had and closed in the last 10 years. The details are extensive and include the type of account (mortgage, loan, credit cards, etc.), creditor, date when it was opened, account balances, credit limits, and payment history. Data on bankruptcies is kept up to 7 years, along with instances of loan defaults by the client and whether they experienced car repossession, foreclosure of property, or their debt was sold off to a collection agency.
Ideally, you’d want this section to remain empty. It contains data on bankruptcies (types, status), civil judgments, divorces, and lawsuits concerning repayment of a debt.
Soft and hard inquiries
Every time an entity wants to access your credit report, the inquiry is logged. Even if you ask to check your own credit report (you are entitled to at least one free report every year), that would be logged in your report (as a soft inquiry). Other instances of soft inquiry are when an employer wants to check your credit or during credit prequalification. On the other hand, a hard inquiry is when you apply for credit (a credit card or loan) and the bank checks your report to make a decision.
Having too many hard inquiries within a short period of time negatively impacts your credit score. Searching for options to get new loans is indicative of accumulating fresh debt, so your report will actually consider hard inquiries as debt even if you don’t take the loan. This is until you show you can handle this new debt (usually within 12 months) – after that, your report is cleared.
Now that you have some understanding of the type of information that is included in your credit report, let’s take a look at the collection process.
The credit bureaus that track your debts
There are three big credit reporting agencies—Equifax, Experian, and TransUnion—and they are tasked with collecting the credit history of clients from creditors. When an entity (i.e. an employer, a landlord, or a potential creditor) wants to check the report, they need to pay these multinational consumer reporting agencies, also known as credit bureaus, to use their credit registry.
Historically, credit registries were first compiled on a larger scale by merchants who wanted to mitigate the risk of extending a loan to someone holding a poor track record with debt management. Equifax, Experian, and TransUnion were consolidated over time from individuals that created lists with credit-related information and sold it to anyone willing to buy it. These three credit bureaus are not the only ones out there, but they are the biggest. They collect their data independently, so minor discrepancies between credit reports for the same person originating from different credit bureaus are possible.
How your credit report is put together
Given the type and detail of personal data required for producing a credit report, you are probably wondering how this record comes about. It’s actually not a legal obligation (there’s some food for thought): the reports come about as a result of the voluntary sharing of information between banks and lending institutions. The laws that are in place regulate the processing of your credit history but not the gathering of data itself (more on that below).
Credit scores and credit report
As you can imagine, the data in these credit records is extensive. Therefore, credit bureaus have to decide what information is relevant to different entities for each individual inquiry. For example, a utility company checking your report is focused on your payment history, while a lending institution wants to be aware of the total amount of debt you hold before granting you a mortgage.
Credit scores were introduced to streamline this process (and to standardize loan terms). VantageScore and FICO are two of the most prominent credit scoring models used today. They distill the information from the report into a three-digit number that expresses your status to potential creditors.
Dozens of different scoring systems are employed for this purpose and some of them are industry-specific (for example there’s a specific score for auto loans). However, the ubiquitous FICO score in regards to creditworthiness, or a person’s ability to repay their debts, is based on a specific model. Values of this score are in the range from 300 to 850, and they are calculated by factoring in payment history (35%), credit utilization (30%), credit history (15%), and credit mix (10%).
You can strive to improve your credit score by studying the scoring methodology for your credit records. There are many reasons to do so because it plays a big role in your financial prospects.
Why is credit reporting important?
Lenders use credit scores derived from credit reports in their decision-making. The first decision they make is whether to lend money to a certain borrower and then they decide on the specifics, such as the loan terms for that applicant at the moment their request was received.
As much as credit bureaus try to do their best to forward accurate information to creditors and other entities, sometimes negligence leads to mistakes in credit reports for a given client. The implication of such inaccuracies can be dire because this may eventually result in the client being rejected for a loan without knowing why.
At least that was the case before the Fair Credit Reporting Act (FCRA) was passed. Back in the 1970s, this was one of the first data protection laws introduced to ensure that consumers were treated fairly when applying for a loan. With it, bank clients earned the right to peek into the information collected about them. The Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CFPB) enforce this law despite a number of challenges, like the alleged discrimination of debtors. Of course, other issues also come up, especially since credit reporting companies handle information about millions of consumers.
If you are new to the topic of personal finances, maybe you are beginning to perceive credit reporting as your next sworn enemy. But in fact, credit reports are what you make of them—inherently, they’re neither good nor bad. Credit bureaus update these records each month, so even if your outlook is not perfect at the moment, you should know that the track record in these reports is not completely out of your control.
It works the other way, too. Just because you enjoy a favorable credit score doesn’t mean you can afford to be lenient. As we mentioned above, payment history contributes to 35% of the score, so if you stop paying your bills on time, the credit report will quickly reflect this.
Why should you care?
A bad credit score will lend you a credit product with higher interest rates and a tight repayment schedule. Even worse, you may not receive credit in the first place. Let’s put this into perspective.
Your credit score matters because even a slight change in the interest rate on a mortgage can result in saving tens of thousands of dollars over decades. The bigger the loan, the bigger the impact.
The basics of checking your credit report
There is a point to passing all that legislation to protect consumers. Let’s examine this.
If lending institutions base their decision of approving a credit line to you on the data compiled in the report, then you should be privy to its contents. And that’s at the very least. What if the report contains inaccuracies? Faulty data you know nothing about will determine your fate. And if that can be prevented by you providing up-to-date info in the credit report, then why not do it? With a few corrections, you could possibly get a more favorable offer.
Institutions like CFPB deal with these kinds of situations on a daily basis. Credit reports may contain misleading information, a number of credit inconsistencies, misapplied charges, and what’s worse, your identity could be mistaken or even stolen.
That, in a nutshell, is why you should check it yourself.
When to check
We especially recommend that you take a look at your credit report before you apply for a loan. Just keep in mind that correcting a mistake in the credit registry of these major bureaus can take up to 30 days, so if your credit application is time-sensitive, you should check your credit report well in advance. Since you are entitled to at least one free credit report a year, you can use that privilege to go over your data. The credit bureaus encourage regular use of their services (i.e. on a quarterly basis), and in times of financial stress, you might have more than one opportunity to check your report.
How to check
OK, you have the report in your hands, but what exactly are you looking at? In essence, you are fishing for information that is not correct because it can hurt your credit score. Mistakes are more common than you might think, so do your due diligence. Below are some tips on typical scenarios of common inaccuracies.
- Errors in personal data
- Getting mistaken for someone with the same or very similar name. Maybe you are not offended when your name is misspelled, but this could allow their credit habit to spill over into your report.
- Having a completely different name on some accounts. In this case, you’re most probably a victim of identity theft.
- An incorrect address, phone number, or similar.
- Invalid account status
- Having an open account listed as closed or vice versa.
- Having late or delinquent payments listed when the account was settled on time.
- Having the same account listed more than once.
- A mistake in the dates; for example, if the date an account was opened is incorrect, this can lead to additional misleading info.
- Errors in account balance
- A mistake in the current account balances.
- A mistake in credit limits for an account
- Outdated information
- Debt that’s sold to a collection agency that has been paid off since.
- Information on an ex-spouse or a civil suit you’ve won in the meantime.
- Any other inconsistency along those lines.
If you happen to find mistakes in your report, there is a process in place to correct them. You need to relay such information to credit reporting companies in an effective manner. Luckily, there are also a lot of templates online for disputing credit report inaccuracies, so you can do it right away.