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Credit history

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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
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....

. The term "credit reputation" can either be used synonymous to credit history or to credit score
Credit score
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...

.

In the U.S., when a customer fills out an application for credit from a bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

, store or credit card
Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...

 company, their information is forwarded to a credit bureau
Credit bureau
A credit bureau , or credit reference agency is a company that collects information from various sources and provides consumer credit information on individual consumers for a variety of uses. It is an organization providing information on individuals' borrowing and bill paying habits...

. The credit bureau matches the name, address and other identifying information on the credit applicant with information retained by the bureau in its files. That's why it's very important for creditors, lenders and others to provide accurate data to credit bureaus.

This information is used by lenders such as credit card
Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...

 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.

There has been much discussion over the accuracy of the data in consumer reports. However, the only scientifically researched studies that include sample sizes large enough to be valid have generally concluded the data in credit reports is very accurate. The credit bureaus point to their own study of 52 million credit reports to highlight that the data in reports is very accurate. The Consumer Data Industry Association testified before Congress that less than two percent of those reports that resulted in a consumer dispute had data deleted because it was in error.

If a consumer disputes some information in a credit report, the credit bureau has 30 days to verify the data. Over 70 percent of these consumer disputes are resolved within 14 days and then the consumer is notified of the resolution. The Federal Trade Commission states that one large credit bureau notes 95 percent of those who dispute an item seem satisfied with the outcome.

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
Risk-based pricing
Risk-based pricing is a methodology adopted by many lenders in the mortgage and financial services industries. It has been in use for many years as lenders try to measure loan risk in terms of interest rates and other fees...

 on almost all lending in the financial services
Financial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...

 industry, this report has become even more important since it is usually the sole element used to choose the annual percentage rate
Annual percentage rate
The term annual percentage rate , also called nominal APR, and the term effective APR, also called EAR, describe the interest rate for a whole year , rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate...

 (APR), grace period and other contractual obligations of the credit card or loan.

Calculating a credit rating


Credit ratings vary from a scoring model to another, but in general the FICO scoring system is the standard in U.S., Canada and other global areas. The factors are similar and may include:
  • Payment history (35% contribution on the FICO scale) - A record of negative information can lower a consumer's credit rating or score. In general risk scoring systems look for any of the following negative events; charge offs, collections, late payments, repossessions, foreclosures, settlements, bankruptcies, liens, and judgements. Within this category FICO considers the severity of the negative item, the age of the negative items and the prevalence of negative items. Newer is worse than older. More severe is worse than less severe. And, many is worse than few.
  • Debt (30% contribution on the FICO score) - This category considers the amount and type of debt carried by a consumer as reflected on their credit reports. There are three types of debt considered.
  • Revolving debt - This is credit card debt, retail card debt and some petroleum cards. And while home equity lines of credit have revolving terms the bulk of debt considered is true unsecured revolving debt incurred on plastic. The most important measurement from this category is called "Revolving Utilization", which is the relationship between the consumer's aggregate credit card balances and the available credit card limits, also called "open to buy." This is expressed as a percentage and is calculated by dividing the aggregate credit card balances by the aggregate credit limits and multiplying the result by 100, thus yielding the utilization percentage. The higher that percentage the lower your score will likely be. This is why closing credit cards is generally not a good idea for someone trying to improve their credit scores. Closing one or more credit card accounts will reduce your total available credit limits and likely increase the utilization percentage unless the cardholder reduces their balances at the same pace.
  • Installment debt - This is debt where there is a fixed payment for a fixed period of time. An auto loan is a good example as you're generally making the same payment for 36, 48, or 60 months. While installment debt is considered in risk scoring systems it is a distant second in its important behind the revolving credit card debt. Installment debt is generally secured by an asset like a car, home, or boat. As such, consumers will use extraordinary efforts to make their payments so their asset isn't repossessed by the lender for non-payment.
  • Open debt - This is the least common type of debt. This is debt that must be paid in full each month. An example is any one of the variety of credit cards that are "pay in full" products. The American Express Green card is a common example. Open debt is treated like revolving credit card debt in older version of the FICO scoring system but is excluded from the revolving utilization calculation in newer versions.
  • Time in file (Credit File Age) (15% contribution on the FICO scale) - The older your credit report the more stable it is, in general. As such, your score should benefit from an old credit report. This "age" is determined two ways; the age of your credit file and the average age of the accounts on your credit file. The age of your credit file is determined by the oldest account's "date opened", which sets the age of the credit file. The average age is set by averaging the age of every account on the credit report, whether open or closed.
  • Account Diversity (10% contribution on the FICO scale) - Your credit score will benefit by having a diverse set of account types on your credit file. Having experience across multiple account types (installment, revolving, auto, mortgage, cards, etc.) is generally a good thing for your scores because you're proving the ability to manage different account types.
  • The Search for New Credit (Credit inquiries) (10% contribution on the FICO scale) – An inquiry is noted every time a company requests some information from a consumer's credit file. There are several kinds of inquiries that may or may not affect one's credit score
    Credit score
    A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...

    . Inquiries that have no effect on the creditworthiness of a consumer (also known as "soft inquiries"), which remain on your credit reports for 6 months and are never visible to lenders or credit scoring models, are:
    • Prescreening inquiries where a credit bureau may sell a person's contact information to an institution
      Institution
      An institution is any structure or mechanism of social order and cooperation governing the behavior of a set of individuals within a given human community...

       that issues credit cards, loans and insurance based on certain criteria that the lender has established.
    • A creditor
      Creditor
      A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...

       also checks its customers' credit files periodically. This is referred to as Account Management, Account Maintenance or Account Review.
    • A credit counseling
      Credit counseling
      Credit counseling is a process that involves offering education to consumers about how to avoid incurring debts that cannot be repaid through establishing an effective Debt Management Plan and Budget...

       agency, with the client's permission, can obtain a client's credit report with no adverse action.
    • A consumer can check his or her own credit report without impacting creditworthiness. This is referred to as a "consumer disclosure" inquiry.
    • Employment screening inquiries
    • Insurance related inquiries
    • Utility related inquiries
  • Inquiries that can have an effect on the creditworthiness of a consumer, and are visible to lenders and credit scoring models, (also known as "hard inquiries") are made by lenders when consumers are seeking credit or a loan, in connection with permissible purpose. Lenders, when granted a permissible purpose, as defined by the Fair Credit Reporting Act, can "pull" a consumer file for the purposes of extending credit to a consumer. Hard inquiries can, but don't always, 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 may consider that person a poor credit risk.

  • 35% - Payment History: Negative information.
  • 30% - Debt: How much and what type?
  • 15% - Length Of Credit History: This is how long you've had credit
  • 10% - Credit Diversity: This is the different types of credit experience you've had
  • 10% - Inquiries (hard): This is when a creditor checks your credit report

Acquiring and understanding credit reports and scores


There are many businesses that aim to make money by providing services to consumers to check their credit reports and confirm the information in them. These companies advertise heavily. In the US, the Fair Credit Reporting Act and its amendments require that any national consumer credit reporting agency (including Experian, Equifax, and TransUnion) and any national specialty consumer reporting agency (including Innovis, PRBC, Teletrack) provide a free copy of the credit reports for any consumer who requests it, once per year. Free annual credit reports for Experian, Equifax and TransUnion may be requested at https://www.annualcreditreport.com. Note that many imposter websites with names similar to www.annualcreditreport.com exist, and users will see promotions for extra credit-checking services that cost money. Carefully following the process and declining for-pay services will allow users to get their free annual credit reports. Also note that the free reports do not include the consumer's credit score. Rather, they provide a list of accounts so users can confirm that no erroneous information is on the reports.

Information from the GSA Federal Citizen Information Center (US government) is available for free download in .pdf form at http://www.pueblo.gsa.gov. Look for the pamphlets "Building a Better Credit Report" and "Your Credit Scores."

The government of Canada
Government of Canada
The Government of Canada, formally Her Majesty's Government, is the system whereby the federation of Canada is administered by a common authority; in Canadian English, the term can mean either the collective set of institutions or specifically the Queen-in-Council...

 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 through http://www.fcac.gc.ca, the site of the Financial Consumer Agency of Canada
Financial Consumer Agency of Canada
The Financial Consumer Agency of Canada is an independent government agency of the Government of Canada. FCAC provides consumer information and oversees financial institutions to ensure that they comply with federal consumer protection measures. Created in 2001, the Agency investigates cases of...

. Paper copies can also be ordered at no charge for residents of Canada.

Credit history of immigrants


Credit history usually applies to only one country. Even within the same credit card network, information is not shared between different countries. For example, if a person has been living in Canada for many years and then moves to the United States, when they apply for credit cards or a mortgage in the U.S., they would usually not be approved because of a lack of credit history, even if they had an excellent credit rating in their home country and even if they had a very high salary in their home country.

An immigrant must establish a credit history from scratch in the new country. Therefore, it is usually very difficult for immigrants to obtain credit cards and mortgages until after they have worked in the new country with a stable income for several years.

Some credit card companies (e.g. American Express) can transfer credit cards from one country to another and this way help starting a credit history.

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
Credit rating
A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Credit ratings are...

.

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 consumer reporting agencies or credit bureaus. The data reported to these agencies are 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.A benefit of scoring was that it made credit available to more consumers and at less cost.

Credit scoring is the process of using a proprietary mathematical algorithm
Algorithm
In mathematics and computer science, an algorithm is an effective method expressed as a finite list of well-defined instructions for calculating a function. Algorithms are used for calculation, data processing, and automated reasoning...

 to create a numerical value that describes an applicant's 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." 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
Probability
Probability is ordinarily used to describe an attitude of mind towards some proposition of whose truth we arenot certain. The proposition of interest is usually of the form "Will a specific event occur?" The attitude of mind is of the form "How certain are we that the event will occur?" The...

 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.

Your credit score is a number calculated from factors such as the amount of credit outstanding versus how much you owe, your past ability to pay all your bills on time, how long you've had credit, types of credit used and number of inquiries. The three major consumer reporting agencies, Equifax, Experian and TransUnion all sell credit scores to lenders. Fair Isaac is one of the major developers of credit scores used by these consumer reporting agencies. The complete way in which your FICO score is calculated is complex. One of the factors in your Fico score is credit checks on your credit history. When a lender requests a credit score, it can cause a small drop in the credit score. 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.

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, 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 insurance, housing, and employment can be denied based on a negative credit rating.

Note that it 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
A trade secret is a formula, practice, process, design, instrument, pattern, or compilation of information which is not generally known or reasonably ascertainable, by which a business can obtain an economic advantage over competitors or customers...

. 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.

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
Social Insurance Number
A social insurance number is a number issued in Canada to administer various government programs. The SIN was created in 1964 to serve as a client account number in the administration of the Canada Pension Plan and Canada's varied employment insurance programs. In 1967, Revenue Canada started...

 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.

See also

  • Alternative data
    Alternative data
    In economic policy, alternative data refers to the inclusion of non-financial payment reporting data in credit files, such as telecom and energy utility payments. Only 39 of 178 economies have credit bureaus that currently track alternative data....

  • Comparison of free credit report websites
    Comparison of free credit report websites
    The following chart compares free credit report websites, including what's free and what kind of credit reports are included.According to the Federal Trade Commission, "AnnualCreditReport.com is the ONLY authorized source for the free annual credit report."...

  • Credit bureau
    Credit bureau
    A credit bureau , or credit reference agency is a company that collects information from various sources and provides consumer credit information on individual consumers for a variety of uses. It is an organization providing information on individuals' borrowing and bill paying habits...

  • Credit card
    Credit card
    A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...

  • Credit rating agency
    Credit rating agency
    A Credit rating agency is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves...

  • Credit reference agency
  • Credit score
    Credit score
    A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...

  • Identity theft
    Identity theft
    Identity theft is a form of stealing another person's identity in which someone pretends to be someone else by assuming that person's identity, typically in order to access resources or obtain credit and other benefits in that person's name...

  • Fair Credit Reporting Act
    Fair Credit Reporting Act
    The Fair Credit Reporting Act is a United States federal law that regulates the collection, dissemination, and use of consumer information, including consumer credit information. Along with the Fair Debt Collection Practices Act , it forms the base of consumer credit rights in the United States...

  • Fair and Accurate Credit Transactions Act
    Fair and Accurate Credit Transactions Act
    The Fair and Accurate Credit Transactions Act of 2003 is a United States federal law, passed by the United States Congress on November 22, 2003, and signed by President George W. Bush on December 4, 2003, as an amendment to the Fair Credit Reporting Act...

  • Fair Debt Collection Practices Act
    Fair Debt Collection Practices Act
    The Fair Debt Collection Practices Act , et seq., is a United States statute added in 1978 as Title VIII of the Consumer Credit Protection Act...

  • Office of Fair Trading
    Office of Fair Trading
    The Office of Fair Trading is a not-for-profit and non-ministerial government department of the United Kingdom, established by the Fair Trading Act 1973, which enforces both consumer protection and competition law, acting as the UK's economic regulator...

  • Remortgage
    Remortgage
    A remortgage is the process of paying off one mortgage with the proceeds from a new mortgage using the same property as security. The term is mainly used commercially in the angla saxon countries such as the United Kingdom and the United States , though what it describes is not unique to any one...

  • Seasoned trade lines