What is a Credit Report? How Does It Work?

In its most basic sense, your credit report is your financial life history of borrowing money. Credit-reporting bureaus or agencies gather, manage, maintain, and share this information. Trust us, you don’t have to lift a finger to create it or disseminate it. As many as 20 credit-reporting bureaus exist; most are specialty reporting agencies. The following three are the biggies:

  • Equifax (www.equifax.com; 800-685-1111)
  • Experian (www.experian.com; 888-397-3742)
  • TransUnion (www.transunion.com; 800-888-4213)

This article details the items in your credit report and who uses this information.

What does your credit report say about you?

As a snapshot of your financial life, your credit report may also indirectly predict your potential behaviors in other areas of your life. The fact that you have a history of making credit card payments late may tell a prospective landlord that you’re likely to be late with your rent, too. 

A history of defaulted loans may suggest to a potential boss that you aren’t someone who follows through with commitments. If you have a foreclosure in your file, it may tell someone that you may take on more than you can handle or are just one unlucky duck. If you’ve declared bankruptcy because your finances are out of control, perhaps you’re out of control in other ways, too.

This snapshot, which brings into focus the details of your spending and borrowing and even suggests your personal life patterns, also paints a bigger picture of two important factors — characteristics that are critical to employers, landlords, lenders, and others. We cover these two critical characteristics in the following sections.

Do you do what you promise?

Your credit history is an indicator of whether you’re someone who follows through with commitments — a characteristic important to most people, whether they’re looking for a reliable worker, a responsible nanny, a dependable renter, or a faithful mate. Needless to say, a person or company who is considering lending you a sizable sum of money will want to know the same.

Based largely on your history of following through with your financial promises, you’re assigned a credit score. People with higher scores generally get the best terms, including lower interest rates and reduced minimum down payments.

People with lower credit scores may not get credit in today’s economy unless they pay higher interest rates and possibly additional fees or insurance. Even then, they may not qualify for anything, under tight approval guidelines.

Do you do it on time?

When it comes to your credit score, following through with your promises is only half of the game. The other half is doing it on time. In the lending business, the more overdue the payment is, the more likely it will not be paid at all — or paid in full. 

This fact is why, as you get further behind in your payments, lenders become more anxious about collecting the amount you owe. In fact, if you’re sufficiently delinquent, the lender may want you to pay back the entire amount at once instead of as originally scheduled. (When it comes to money, your creditors’ faith in you is only 30 to 90 days long. Car dealers, notoriously short on faith, see the end of the world happening in credit terms in a payment that’s late by as little as two weeks.) 

So the longer you take to do what you promised, the more it costs you and the more damage you do to your credit score.

Uncovering your credit report’s details

Many people believe that your credit report contains the intimate personal details of your life, ferreted out from interviews with your neighbors, your ex, and your business associates. Not true! 

You can rest assured that your credit report doesn’t reveal whether you tend to drink too much at office parties, whether you sport a tattoo, or whether you had an eye-lift or indulged in a wild fling on your last vacation to Mexico.

The information in your credit report is specific, purely factual, and limited in scope. What it lacks in scope, however, it makes up for in the sheer volume of material and the length of time it covers. If students cut a class, chances are no one will notice, but if they fail to pay a bill on time, a multibillion-dollar industry will notice, record it, and tell everyone who asks about them for the next seven years.

Consider the short take on what’s in your credit report:

1). Personal identification information, such as your name, Social Security number, date of birth, addresses (present and past), and most recent employment history.

Be consistent with your information, especially how you spell your name and address. Name, address, and date of birth are the most common sources used to identify which file is yours. The Social Security number is fourth.

2). Public-record information on tax liens, judgments, bankruptcies, child support orders, and other official information.

3). Collection activity for accounts that have been sent to collection agencies for handling.

4). Information about each credit account, open or closed (also known as trade lines), such as whom you owe, the type of account (such as a mortgage or installment account), whether the account is joint (shared with another person) or just in your name, how much you owe, your monthly payment, how you’ve paid (on time or late), and your credit limits.

5). A list of the companies that have requested your credit file for the purpose of granting you credit: Requests are known as inquiries and are one of two types:

  • Soft inquiries are made for promotional purposes (for instance, when a credit card issuer wants to send you a hot offer). These inquiries don’t appear on the version of your credit report that lenders see. They are on the consumer’s copy that you get.
  • Hard inquiries are made in response to a request from you for more or new credit. These inquiries do appear on the lender’s copy of your credit report.

6). An optional message from you, up to 100 words in length, that explains any extenuating circumstances for any negative listings on your report.

7). An optional credit score: Your credit score is not really part of your credit report; it’s an add-on that you have to ask for. Your score probably is different for each credit report because of data differences.

Credit reports are easy to read, although there’s still room for improvement. Each of the three major credit-reporting agencies reports credit information in its own unique format. The credit-reporting agencies compete with each other for business, so they have to differentiate their products.

Among the list of items not included in your credit report are your lifestyle choices, religion, national origin, political affiliation, sexual preferences, friends, and relatives. Additionally, the three major credit-reporting agencies do not collect or transmit data on your medical history, checking or savings accounts, brokerage accounts, or similar financial records.

You can see sample credit reports from Equifax, TransUnion, and Experian online at the sites listed here. You may have to hunt a bit for them on the sites, but they are there, along with endless offers to buy your report and credit monitoring:

Who uses the info in your credit report?

Every day, businesses rely on the information in your credit report to help them decide whether to lend you money and at what price (otherwise known as the interest rate and loan terms). But because the information in your credit report can be sliced and diced in many ways, your report becomes an important tool that serves different purposes for different people:

For a lender, your credit report is a tool to determine how likely and able you are to repay a loan, and it’s an indicator of how much interest and what fees to charge you based on the risk profile you represent — if you qualify for a loan or refinance at all.

For an insurance company, your credit report is a tool to predict how likely you are to have an accident or have your house burn down.

For an employer, your credit report is a tool to predict whether you’ll be a reliable and trustworthy employee.

For a landlord, your credit report is a tool to determine whether you’re likely to pay the rent on time or at all.

For you, your credit report is a tool to help you understand how you’ve handled your finances in the past and how you’re likely to handle them in the future.

Many different types of people can look at this information and make an increasing number of significant decisions that can affect your life. For this reason, double-checking this information is essential. Establishing a positive credit history as soon as possible can help with jobs, insurance, and more.

Understanding How Bad Stuff Gets in Your Credit Report

Whether you’re new to the world of credit or you’re an experienced borrower, you need to keep a few key concepts in mind as you look over your credit report. 

Like the person who can’t see the forest because there are too many trees in the way when you get your hands on your credit report, you may be blinded by the amount of information. In the following sections, we help you focus on what matters and let go of what doesn’t.

1. Don’t expect a straight-A report card

You aren’t perfect. (We hate to have to be the ones to tell you this, but if you aren’t married, someone has to!) The same goes for your credit report — and lack of perfection isn’t a big deal, as long as your credit report shows more smooth patches than bumps. No matter how early you mail off that bill payment, it can still arrive late or get lost, which means you can expect to find some negative information on your credit report from time to time. The good news is that you can still be eligible for plenty of loans at competitive rates and terms without having a flawless credit report or qualifying for credit sainthood.

But how many bad marks are okay? How long do they stay? And how will lenders who view your report interpret them? For example, say you’re a well-heeled, easy-going gal and you loan your boyfriend $5,000 for a very worthy cause. He promises to pay you back monthly over two years. But after four months without a payment, two things likely will happen: He’ll no longer be your sweetie, and you’ll have mentally written off any chance of collecting the debt. Plus, if you’re smart, you’ll think twice before lending money to a friend again. You may even mention the negative experience to your friends, especially if they were thinking of floating him a loan.

If you were to run into your ex-boyfriend sometime down the road, you’d probably mention the $5,000 — after all, you want your money back, and he still owes you. Whether you’d ask him to join you for dinner is another matter and may depend on his showing you some good-faith gesture.

In business, as in love, trust and faithful performance are keys to success. A creditor can tell your future and current creditors any repayment information that is correct and accurate through your credit report, in the same way, that you can warn your friends about your ex-boyfriend. That information or warning may be modified at any time, as long as the new information is correct and accurate.

Just how much does a mistake cost you when it comes to your credit report? Well, it depends on your history. Along with the credit report and all the information that it contains, lenders can buy a credit score based on the information in the report. That score comes from a mathematical equation that evaluates much of the information on your credit report at that particular credit bureau. By comparing this information to the patterns in zillions of past credit reports, the score tells the lender your level of future credit risk.

So people with a lot of information in their credit files will find that a lot of good credit experiences lessen the effect of a single negative item. Score one for the old folks with long credit histories! 

If you’re a young person or a new immigrant with only a few trade lines and a few months of credit history (sometimes called a thin file), a negative event has a much larger effect in relation to the information available. Many young people think the world is stacked against them. In this case, it’s true — but to be fair, it’s also stacked against anyone with a limited credit history, regardless of your age or what country you come from.

2. Checking for errors: Creditors aren’t perfect, either

Other people make mistakes, too — even banks and credit card payment processors. Considering that about 4.5 billion pieces of data are added to credit reports every month, it shouldn’t be a big surprise that incorrect information may show up on your credit report. And we won’t even get into the unrelated problem of errors caused as a result of identity theft. 

A number of conflicting studies have been done on what percentage of reports contain errors and, of those errors, how many were serious enough to affect either the terms under which credit was granted or whether credit was granted at all. So you may or may not have errors on your report. And they may or may not be serious. But unless you’re feeling really lucky, we strongly suggest that you find out what’s in your report.

Still, credit-reporting agencies have a vested interest in the accuracy of the information they report. They sell it, and their profits are on the line if their information is consistently inaccurate. If credit-reporting agencies consistently provide error-riddled data, companies that grant credit won’t be as eager to pay money to get or use a bureau’s credit reports.

Getting a copy of your credit report gives you a chance to check for these errors and — better yet — get them corrected! You can have inaccurate information removed by one of two methods: contacting the credit bureau or contacting the creditor.

3. Contacting the credit bureau

If you notice incorrect information on your credit report, contact the credit bureau that reported the inaccurate information. Each of the three major bureaus allows you to dispute information in your credit report on its Web site, or you can call the bureau’s toll-free number.

If you make your dispute online, you need to have a copy of your credit report available; the report includes information that allows the bureau to confirm your identity without a signature. 

If you opt to call the toll-free number, you’re unlikely to get a live person on the other end — this stuff is heavily automated — but you’ll be told what information and documentation you need so that you can submit a written request. After you properly notify the credit bureau, you can count on the action.

The Fair Credit Reporting Act (FCRA) requires credit-reporting agencies to investigate any disputed listings. The credit bureau must verify the item in question with the creditor at no cost to you, the consumer. 

The law requires that the creditor respond and verify the entry within 30 days, or the information must be removed from your credit report. The credit-reporting agency must notify you of the outcome. If the information in the report has been changed or deleted, you also get a free copy of the revised report.

4. Contacting the creditor

The Fair and Accurate Credit Transactions Act (commonly referred to as the FACT Act or FACTA) covers another way to remove inaccurate information from your credit report. Under the provisions of the FACT Act, passed in 2003 and rolled out in pieces through 2005, you can deal directly with the creditor that reported the negative information in the first place. Contact information is shown on your latest billing statement from that creditor.

We strongly suggest that you do everything in writing, and return the receipt requested. After you dispute the information, the reporting creditor must look into the matter and cannot continue to report the negative information while it’s investigating your dispute.

For new delinquencies, the FACT Act requires that you be notified if negative information is reported to a credit bureau. That said, you may have to look closely to even see this new notice. 

Anyone who extends credit to you must send you a one-time notice either before or not later than 30 days after negative information — including late payments, missed payments, partial payments, or any other form of default — is furnished to a credit bureau. This stipulation also applies to collection agencies, as long as they report to a credit bureau. The notice may look something like this:

  • Before negative information is reported: “We may report information about your account to credit bureaus. Late payments, missed payments, or other defaults on your account may be reflected in your credit report.”
  • After negative information is reported: “We have told a credit bureau about a late payment, missed payment, or other default on your account. This information may be reflected in your credit report.”

The notice is not a substitute for your own close monitoring of your credit reports, bank accounts, and credit card statements.

Looking at the accurate information

Most of the information in your credit report likely is accurate. A popular misconception is that data stays on your credit report for seven years and then drops off. What really happens is that negative data stays on your credit report for seven years, although a few items remain longer, such as a Chapter 7 bankruptcy, which stays on your report for ten years. Even though the negative information is included for a long time, as the months and years roll by, it becomes less important to your credit profile. 

The fact that you were late in paying your credit card bill one time three years ago doesn’t concern most creditors. Positive information, however — the good stuff everyone likes to see — stays on your report for a much longer time. Some positive data may be on your report for 10, 20, or even 30 years, depending on whether you keep your account open and depending on each bureau’s policy.

Unscrupulous lenders may use negative information as a reason to put you into a higher-cost loan (and a more-profitable loan, for them), even though you qualify for a less-expensive one. This is just one example of a situation in which understanding your credit score can save you money

The scenario can go something like this: You’re looking for a loan for a big-ticket item. Instead of going from bank to bank and wasting days of precious free time or risking being turned down after filling out long applications and explaining the $5,000 your ex-boyfriend owes you, you go to a trusted financial advisor who knows how these things work. 

She pulls your credit report and shops for a loan for you. Your answer is that this is “a great deal considering your credit score.” Translated, this answer means you’re being charged a rate higher than the market rate because of your imperfect credit score. 

If you don’t know what your score is and what rate that score entitles you to in the market- place, you may be taken advantage of. Learn more about how to read your credit scores.

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