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General Credit Information (I) – What is a Credit Score?
UNDERSTANDING CREDIT – PART 1
Credit scores are used by lenders as part of their lending “guidelines.” Consumers have access to their credit reports and credit score, and can use this information post-bankruptcy to quickly restore themselves. To be more specific, many of our clients have 700+ FICO scores within 12 months of filing bankruptcy. This article is to provide the basic idea of how a credit score is created. In the next section, we’ll break down the 5 components. As a disclaimer, the information is meant to be general in nature and is not legal advice. This information is based off of personal experience with lending guidelines, creditor representations, and general observations. That said, Tucson Law Center, i.e. our law firm, is committed to ensuring you regain a positive credit score.
A FICO® SCORE. Most credit scores are computed using software created by Fair Issac Corporation (FICO). FICO ® Scores range from 350 to 850 and are used by lenders as a numerical value to determine whether a consumer qualifies for a particular credit request. Because a credit score is a calculation based off of information that is constantly changing, a credit score does not exist until it is actually requested. Once generated, the score is weighted heavily on current behavior to predict future behavior, such as a potential default. The last two years of information seem to predominately drive the score. This means 1) it’s easy to put the past behind you, and 2) aged information carries less and less impact on a score (this is helpful to how bankruptcy cleans up negative credit).
This score will almost always vary among the three credit reporting agencies. Therefore, banks will typically extend credit based off of the middle FICO ® Score. This score can affect qualifying for a loan, employment opportunities, and insurance premiums. Research has shown that individuals with lower credit scores have a higher likeliness of filing insurance claims, therefore bad credit equates to higher insurance premiums (approximately 90% of insurance companies charge premiums based on credit scores).
It is paramount that individuals review their credit and take steps to improve it. This process begins with understanding the components of a credit report and then learning how to improve the areas that effect scoring, which includes confirming the accuracy of their report and disputing any typos or errors. I’ve been told by one credit expert that approximately 29% of credit reports contain inaccurate “derogatory” information and roughly 20% are missing positive information that would improve a credit score.
Getting Your Credit Score. It is easier now that ever to get your credit reports and score. Many clients use Credit Karma to review their credit. This company even has a phone app, which is tremendously helpful. Credit Karma can be found at the “app store” or their website at: https://www.creditkarma.com. I believe it is free, and again, many of our clients use it. Another helpful site is: https://www.annualcreditreport.com. This is the official site to retrieve the most accurate version of your credit report, and it’s sponsored by Equifax, Experian and TransUnion. Within this site, a consumer can request all three of their free credit reports (as required by Federal law that credit reports be available “free” on an annual bases to consumers).
Once you obtain your credit reports, it’s important to review each section. The report consists of four sections and these sections are used to create your credit score. The score is generated by categorizing your information into five components, which are discussed in the next section. If this is confusing, think of your credit information as sections of a resume. Next, think of your credit score as an employer’s evaluation based on five particular skillsets. Using this analogy, a lender is similar to an employer with respect to deciding whether to lend/hire you based on your information. Obviously, you want to review each section and make sure it’s as complimentary as possible.
The credit report starts with an individual’s personal information. It provides names, former names, aliases, past and current addresses, employment history, and can even have marital status. A consumer wants to make sure the information is accurate and remove any typos, inaccuracies, or outdated information. The next section provides credit trade lines, including accounts, balances, status, open/close date, etc. After filing bankruptcy, these trade lines should be reporting as “Discharged in Bankruptcy” with $0.00 amount outstanding. The third section shows public records, including bankruptcy filings, judgments, liens, etc. Fortunately, a filed bankruptcy carries little weight in calculating your credit score. Finally, the last section is credit “inquiries” where someone has accessed your credit report. The sections of a credit report are helpful to know and it’s important to review them for accuracy. This will help ensure a quick recovery to a high credit score.
A high credit score translates directly to lower interest rates, more relaxed lending guidelines, and cheaper premiums, as insurance companies and other industries are now relying on credit reports to determine rates. Employment opportunities can also pivot on an individual’s credit report, particularly with jobs in the financial sector or with jobs requiring a security clearance. In the next section, we break down the five components and demonstrate how bankruptcy actually improves a credit score. After reading the next section, you’ll see how bankruptcy is one of the most powerful tools to quickly and effectively improve a credit score.