- 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 .
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.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 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
concluded that by and large 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 satified 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 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.
How credit rating is determined
Credit ratings are determined differently in each country, but the
factors are similar, and may include:
- Payment history - a record of delinquent payments, 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.
- 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.
- Re-Aging - Through re-aging, the date of last action on the account is
changed. This can dramatically alter the credit score. In 2000, the
Federal
Financial Institutions Examination Council (FFEIC) clarified
guidelines on re-aging accounts for delinquent borrowers. [111335] (PDF)
- Utilization—Lenders ascribe increased risk to accounts with
balances near their limits.
- Credit inquiries – 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. Inquiries that have no
effect on the creditworthiness of a consumer (also known as "soft
inquiries") are:
- Prescreening inquiries where a credit bureau may sell a
person's contact information to an institution that issues credit cards, loans and
insurance based on certain criteria that the lender has
established.
- A creditor also checks its customers'
credit files periodically.
- A credit counseling 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.
- Inquiries that do have an effect on the creditworthiness of a
consumer (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 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 may 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 necessarily improve
your score. Many risk models consider the difference between the
amount of credit a person has and the amount being used: closing
one or more accounts will reduce your total available credit, lower
the percentage of available credit, and possibly lower your credit
score. Risk models also factor in account age: closing an account
with several years of history that is in good standing will most
likely negatively affect your score.
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. However,
U.S. Law requires that the three major credit reporting agencies
(Experian, Equifax, and TransUnion) provide a copy of the credit
reports for any consumer that requests it, once per year. The
website to order this legally-required and free service is
https://www.annualcreditreport.com. Note that even carrying out the
steps to acquire these reports, 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, legally-mandated reports. Also note that the free
reports will not tell you an actual credit rating number, which is
not their goal. Rather, they provide a list of accounts so users
can confirm that no erroneous information is on the reports.
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.
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.
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 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 to create a numerical value that
describes 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." 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.
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 calcualted
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, 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 insurance, housing, and employment can 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. 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 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
References
-
http://www.washingtontimes.com/news/2009/jan/19/credit-agencies-are-the-messengers/
-
http://www.federalreserve.gov/pubs/bulletin/2004/summer04_credit.pdf
-
http://www.michigan.gov/documents/cis_ofis_allstate_testimony_36911_7.pdf
-
http://www.house.gov/apps/list/hearing/financialsvcs_dem/ospratt061907.pdf
-
http://www.house.gov/apps/list/hearing/financialsvcs_dem/ospratt061907.pdf
-
http://www.ftc.gov/os/comments/fcradispute/P044808fcradisputeprocessreporttocongress.pdf
- Turner, Michael A et al., Give Credit Where Credit Is
Due, Political and Economic
Research Council, 1.
-
http://www.federalreserve.gov/boarddocs/RptCongress/creditscore/creditscore.pdf
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