Caryn graduates from college and starts a new job. Her car is old and she decides to buy a new one since zero percent financing is available. After negotiating a good price with the dealer, Caryn finds that she does not qualify for the zero percent rate because her credit score is not high enough. The culprit: No established credit history.
Jane and Jay want to refinance their mortgage because interest rates are low and the lower mortgage payments would ease their tight cash flow. After meeting with the loan officer, they find that the bank is not willing to refinance their loan because of changes in their credit report. The culprit: Late payments, partial payments and high credit card balances.
Christopher receives a tentative job offer from a great company that will provide good benefits and a generous salary. However, before his hire date, the employer declines the offer. The culprit: Collection for nonpayment.
What our fictional consumers failed to realize was the power of their credit scores, who looks at credit scores and the importance of maintaining good credit.
At one time, only lenders ran credit reports; but, in today’s world, employers, insurance companies and utility companies use credit reports and credit scores when making decisions. A good credit score will open doors and save a person money through lower interest rates and insurance premiums. A low credit score will have the opposite effect, and those with low scores may find themselves paying much higher prices for services and loans.
Recent statistics on late payments and delinquencies are astounding, with the number of late payments, collection actions and bankruptcies growing. According to a 2009 survey by the National Foundation for Credit Counseling, 26 percent of all Americans admit to not paying all of their bills on time. Among African Americans, 51 percent make that claim.
Sallie Mae’s study on “How Undergraduate Students Use Credit” indicates that one-third of college students pay their tuition with a credit card. Of those students, 60 percent said they were surprised by their high balances, and they did not have enough income to make the minimum payment.
A whopping 65 percent of a credit score is based on outstanding credit and payment history. Managing debt by reducing both available credit and outstanding debt and by paying bills on time is the best way to maintain and raise a credit score.
Checking a credit report on a regular basis, contacting credit agencies to correct information, creating a plan to get out of debt and keeping credit card balances below 35 percent of the available credit all help to keep credit scores in the high range.
Consumers need to be aware of some pitfalls when attempting to raise credit scores. For instance, the length of time a person has had credit is important. Therefore, if it is necessary to close some accounts to lower the amount of available credit, it is best to close those with the shortest history and to keep the oldest accounts open. Also, whenever a consumer applies for credit, the lender runs a credit check, which becomes part of the consumer’s file. Too many credit checks may be an indicator of too much available credit.
There is a saying that time heals all evils, and that advice applies to credit scores. Consumers need to give themselves time to establish or re-establish a history of responsible credit management and bill payment. Paying the minimum due each month before the due date helps to raise a credit score and allows lenders to see that a person will repay loans in a timely manner.
Lastly, consumers who do not have an established credit history or need to repair their history should consider a secured credit card. Consumers deposit money into an account with the lender and then can borrow, via the credit card, against the account. Available through many lenders, a secured card is a measure that, if used responsibly, will help raise a credit score.
Credit reports are available to consumers free of charge through a variety of sources. The government-authorized web site, AnnualCreditReport.com, allows consumers to receive one free credit report a year from each of the three credit reporting agencies: Equifax, TransUnion and Experian.
Other web sites, like Credit Karma, offer free reports, credit scores and a plethora of credit information and interactive calculators and graphs. Consumers should be advised that some web sites claim they are free but in reality are trying to sell credit-monitoring products. Many will not provide the “free” credit report unless the consumer enters a credit card number and signs up to use the product.
Looking at a credit report can be an eye-opening experience, and many consumers start to understand why their credit score is lower than they anticipated. Late and nonpayment notices, the number of open accounts and the amount of available credit all play a significant role in credit score creation.
If a consumer has problems because of a bad credit report, the first step is a defensive one: Go back to the source of the information—the credit report.
Consumers should look for incorrect information and contact the credit-reporting agency to take steps to correct the information. Experian, Equifax and TransUnion all have web sites where consumers can submit discrepancy information online or print forms to mail back to the agency. Once the agency receives the disputed information, it will investigate the claim and correct incorrect data.
If there are credit accounts on the report that the consumer did not establish, they may be a victim of identity theft and should immediately put fraud alerts on the credit report with all three agencies, close all accounts they did not open and file a report with their local police department and with the Federal Trade Commission.
Consumers also need to be honest with themselves about their situation. While some people have credit problems because of a life experience such as job loss, illness or divorce, other people simply live beyond their means and use credit to supplement their income. Creating and living on a budget is one way to resolve this issue. A number of reputable resources help consumers learn about budgeting and debt reduction. The National Foundation for Credit Counseling’s web site offers detailed self-help information, including worksheets and calculators. In addition, contact information for reputable counseling agencies is available for consumers who would like individualized help.
Consumers can also contact their creditors and ask for help. A creditor’s goal is to collect the money that is owed them, and many are willing to change billing dates and, in some instances, may even lower the minimum payment.
Keep up with what’s new and noteworthy at the St. Louis Fed. Sign up now to have this free monthly e-newsletter emailed to you.
Fed in Print: An index of the economic research conducted by the Fed.