The infancy of the consumer credit scoring system was established many years ago by a company then known as TRW (today it is called Experian, one of the three major credit scoring companies in the United States). Back then the idea of using a scoring system to make credit decisions was not well established in the business community. TRW’s idea grew over time and with the emergence of faster and more powerful computer systems, consumer credit scoring evolved to what it is today. In fact if it were not for the rapid development of computers, there would be no scoring system. I will not focus on the legal issues and Federal and State laws which were enacted in response to the growth of credit scoring, instead I will focus on how the system works and what you need to know to not only protect yourself from credit fraud but to help improve your credit score so that you can utilize it to your benefit instead of having the system take advantage of you. A future article will be written to discuss the many legal protections the government has enacted over the years in order to help people avoid being abused by the credit system. Many aspects of the scoring system are illogical and I will not attempt to apply the rules of logic. I will simply state the facts.
Actually the credit scoring system is quite simple in its concept. Each individual in the United States has a credit score which is a number from 300 to 850. Each of the three major credit reporting agencies, namely Experian, Equifax and TransUnion publish a score for every individual. Their process is simplistic. They obtain monthly credit history information from every creditor they can possibly identify as having a relationship with you and then they take that raw data and apply their own secret formula to the information in order to generate your credit score. Many readers may have heard of a term called a FICO score in relationship to your credit score.
This is because during the development of scoring a company called Fair Isaacs Company convinced the credit reporting agencies that they had created the best formula for predicting credit behavior and all of the reporting agencies use their model. One interesting fact is that they keep the scoring formula secret and that they each use the scoring model differently thereby causing each reporting agency to publish a different score value from each other.
In the big picture the way the scoring system works is when you apply for any type of credit whatsoever, the prospective credit grantor obtains your credit report from the three credit reporting agencies. Some obtain all three reports some either one or two. They then make a decision about your request for credit by applying their own standards for credit granting as it relates to your score. For example, if a mortgage company is approached by a prospective borrower and the borrower’s score is 625, however the mortgage company will not lend unless the credit score is 650 or better, then they turn down the application no questions asked. Each credit grantor establishes their own internal standard which they use to make all of their credit decisions.
Clearly it is obvious that the higher your credit score the better your opportunity to obtain credit. So it would seem naturally simple for everyone to make certain that their credit scores stay high in the event that they want to apply for credit of some kind.
Well, actually it is not that simple to achieve the goal of high scores. In fact millions of Americans suffer with credit scores that may be deemed to be too low for many potential credit grantors. Surprisingly many who pay all of their bills on time can easily find themselves in the credit scoring trap and have absolutely no clue as to why they are in that position.
There are a few basic facets of the credit scoring system that all need to know if you are to succeed in maintaining a good credit score. This is more important today then ever before. In the past the scoring system was used exclusively to determine if an applicant was going to be granted credit. Today it has grown far beyond that focus. Now it has come this. Your credit score will more than likely be evaluated if you apply for a job, apply to rent an apartment, apply for insurance and many more areas of your life outside of borrowing money or obtaining credit. It has become so large that careers can be ruined, livelihood can deteriorate and many other negative side effects can be felt with a low credit score.
Although the credit reporting agencies will not publish their secret formulas and how they apply them to each individual, some information about how you handle your credit and its effect has been observed by credit counseling agencies. Unfortunately these details are now widely published. This information is vital to your credit health and well being.
Some of the simplest problems can be easily cured. Take for example the individual who prides themselves on never using credit in any way whatsoever. This person believes that they are a find upstanding and responsible member of society who can be counted upon to meet all of their obligations. The one problem that they will eventually have to face is that they have absolutely no credit score. Since they have no relationship with any credit grantor, the credit reporting agencies have nothing to score so they all report no score at all. This is not good if such a person decides to buy a home and apply for a mortgage or a credit card. They will be turned down even though they have conducted themselves in the most responsible manner financially. The credit scoring system has no mercy, you are either approved or declined.
Therefore we can all assume that we need some form of credit just so we register on the credit reporting system. Without a decent credit score we are bound to have real problems in dealing with many aspects of our life. The following thoughts are valid for a person who has never had credit as well as a person who has had bad credit and wants to re-establish a favorable credit score.
If you think the problem of having no credit is easy to solve you are wrong. You see it becomes a chicken and egg situation. If you have no credit score you cannot obtain credit. Trying to qualify for a regular credit card without a credit score is a waste of time. So what must one do if they have no credit score at all? The solution is to obtain a secured credit card. This product is readily available and a simple Internet search will yield many results. What you want to guard against is the army of hucksters who will offer your secured credit cards at a very exorbitant price. My advice is simple, let the buyer beware. Do your homework and make certain that you locate those companies who offer a fair deal when it comes to granting you a secured credit card.
Once you have obtained your secured credit card you need to be aware of how to use it to maximize its credit scoring impact. First, do not open more than one secured credit card account in any sixty day period. Believe it or not establishing several credit accounts in a short space of time actually reduces your credit score. Once the accounts are open make certain to utilize each account on a regular basis. Also be sure to not exceed 40% of the credit limit on each account monthly. This is very important and I will discuss it later in this article. The last thing to remember to do is to pay off the entire credit card bill each month. Do not leave a balance. It is not important how much you charge each month, the important aspect when it comes to credit scoring is that you pay off the entire balance.
One of the key features of the scoring system that has emerged to observers is the time element in your credit experience. The longer you use credit the stronger your score becomes. As time goes by the monthly credit score calculations made by the reporting agencies improves. So do not think that you can obtain a couple of secured credit cards and have immediate good credit scores. It is not that simple. However, if you follow this procedure you will receive offers for regular credit cards soon enough. Usually within six months you may see offers showing up in your mailbox. Again at that time I urge you to evaluate them carefully and try to choose the least expensive ones that come along. Do not just accept the first offer you may get. There are other aspects you must know about. However, one of the strongest tools is to establish credit and utilize it properly over time.
Now consider the individual who has credit, pays all of their bills on time only to learn that they have a very depressed credit score. How can this be? If I pay all my bills on time and have credit should I not have a good credit score?
No, not if you do not follow the guidelines required to be interpreted by the scoring system as good credit. First and foremost, if your credit balances exceed 40% of your credit limit, even though you pay on time, your credit score suffers and is depressed. A key feature of the scoring system is the ratio of your outstanding credit as compared to your debt limit. What this means is that if you have a credit card with a $1,000 credit line and you utilize more than $400 of it in any monthly cycle you are lowering your credit score.
This is why millions of people who have maximized their credit lines and pay the minimum payment each month have low credit scores. The scoring system punishes them even though they are making payments on time each month. Until they bring those balances down to below the 40% level, their scores will remain low.
Another key aspect of the scoring system is the variety of credit you have. If all you have is credit cards the scoring system will not reward you as well as it could. You can increase your credit scores by obtaining a variety of types of credit. Each form of credit different from the others will help increase your scores. Take the person who may have an average of five credit cards and nothing else. Their credit score might be acceptable if they use the cards responsibly, however their scores can be significantly increased by obtaining a variety of types of credit. Some excellent ways to build up your credit spectrum includes obtaining department store and other retail store credit cards, gasoline company cards, automobile leases or loans, computer financing from a major brand or any other financing arrangement including obtaining a personal loan from a bank. Be certain to make sure that if you work with a smaller company or bank that may be granting you credit such as a furniture store or a local community bank that they report the monthly credit experience from their customers to at least one of the three major reporting agencies. If they do not report then obtaining credit from them will not help in any way to increase credit scores.
Following the above steps will insure that your credit score will increase and that you will not be held back by the scoring system whenever it comes into play in your life. One last but most important aspect to maintaining good credit scores is to try to avoid credit identity theft. Unfortunately this has become one of the greatest failures of the credit system in our society and once again if it were not for the availability of powerful computers, this crime would not have reached the proportions it has. It is estimated that we lose billions of dollars every year to criminals who steal credit identity and then fraudulently use it to their benefit. Not only does this cost us so much money, but the worst part is the effect it can have on your credit scores.
Anyone whose credit identity has been stolen will experience the horror of realizing that although they have done nothing wrong, the credit scoring system is not yet sophisticated enough to protect them from grave harm. I have seen many cases where a person’s credit identity has been used to charge large purchases using their credit. Although this person has the right to not have to pay the fraudulent charges, the impact on their credit scores will be devastating for years to come. The credit reporting system does not have the ability to wipe out all of the fraudulent behavior that may have been transacted using stolen credit identity. No matter how many consumer statements you may attach to a credit report, the scoring system itself simply does not have the capacity to pick and choose which credit files they will accept and which to ignore. The scoring system simply takes all of the raw data out there and applies its formula. That’s it.
Take great caution in using your credit cards everywhere in life. When at a restaurant or store, if there is a carbon copy within the credit card receipt which you must sign be certain to tear off the carbon and take it with you to destroy later. Never leave the carbon copy behind. Unscrupulous employees may take that information and use it against you later.
In ordering products on the Internet, never do business with a vendor who does not offer encryption of their data. This can usually be found on their website somewhere. If you cannot confirm that they use this type of protection you should call the company and ask them outright. If they cannot assure you that they protect their credit card customers this way you should not give your credit card information on their website. If you must purchase something from them send them a check in the mail. Even if you are in a big hurry for their product, better to wait a week or so while your check clears than having to face the nightmare of credit identity theft.
Never let a friend or relative use your credit cards. They may unintentionally use your card in such as way as to compromise your information and permit the large army of credit identity thieves to steal your data. Once they get their hands on your information all bets are off and you will suffer greatly. If you must help a friend or relative with a purchase, go with them and use your card. Do not let anyone else use it, ever.
Many people have fallen victim to a relatively recent Internet phenomenon labeled “phishing”. This is when you get an email that looks like an official message from a trusted bank or credit card company. The message will always ask you to confirm your private information for some made up purpose such as “we are updating our records and your account will be cancelled unless you confirm your information” or some silly thing like that. If for a minute you think it is actually your bank or credit card company forget it. Legitimate businesses do not operate that way. If you have any doubt look for a telephone number in the message and if there is one call them. You will reach a scamster at the other end of the telephone and you can easily confirm that by suggesting that they give you some of your vital information from your account first and then you can confirm it for them. They will hang up quickly. Usually though there is no telephone number at all but a link which takes you to what appears to be an official website of the company. This is a major fraud and you can ignore it as soon as you see it in your email. If you still have any doubts and don’t want appear uncooperative just in case it is your bank or credit card company, call the bank or card company using the telephone number they provide on their monthly statement. Ask them if they are conducting an Internet campaign to confirm their customer’s information. You will be glad you did.
The most important thing you can do to maintain your good credit scores is to review your credit reports periodically. Anyone can obtain one free report each year. Recent legislation requires the credit reporting companies to provide each and every individual with one free credit report annually. All you have to do is log on to your computer and vist http://www.annualcreditreport.com where you can fill in your information and obtain your one free credit report each year. You need to scan that report carefully and make certain that all of the information is accurate. If it is not you must write to the credit reporting agency that has the incorrect information and advise them to correct the mistake.
Review your credit at least twice a year and follow the above ideas to insure that your credit score will always be high.