As promised, here is part two to our discussion about lending. In this segment I’ll talk about what is listed on your credit report, what does and doesn’t affect your score and for how long, and finally what lenders are looking at on your credit report.

Knowing the Basics

The first thing you have to know about credit reports is that they are generated by three different credit bureaus who all use different scoring models – which accounts for the difference in scores between the bureaus. The three credit bureaus are:

•    Equifax (most common) – Beacon scoring model
•    Experian – FICO scoring model
•    TransUnion (least used) – Empirica scoring model

As you know, you are entitled to a free credit report from each of the three credit bureaus once a year. I always recommend to my clients to get one every four months, that way you don’t have to wait an entire year between checking credit reports to see if you have any errors. The information on each credit report is usually the same so you’re keeping a constant eye on your information.

What kind of information is on a credit report?

•    Identification information: this includes name, address, aliases, phone numbers, etc.
•    Credit history: this section provides on-going historical and current record of a consumer’s buying and payment activity.
•    Public records: this includes any tax liens, court judgments, or bankruptcies.
•    Inquiries: All inquiries, including employment. The only ones that don’t show up are those that you initiate yourself.

How are credit scores determined?

This will vary slightly with each scoring model, but the standard percentage model based on what is most important in determining your score is as follows:

•    35% – payment history
•    30% - amounts owed
•    15% – length of credit history
•    10% – new credit
•    10% – types of credit used

As you can see, paying your bills on time has a large impact on your credit score, followed closely by your debt. When your credit cards are maxed out, your score will drop.

Things that don’t affect your credit score are debt-to-income, income, and length of residence. However, this type of information is important later on when we talk about what lenders look for on credit reports.

Certain inquiries (”soft” inquiries) are not counted against your score. For instance, the scoring models ignore inquiries within 30 days of getting a mortgage or car loan. The models also count two or more “hard” inquiries within the same 14 day period as just one inquiry. Despite that you’ve been told an auto dealer who runs your credit through multiple times has lowered your score, the scoring models count all of those as one inquiry. They do show up on your credit report; however, they don’t all count against your score. Additionally, “hard” inquiries are tracked on the credit report for 24 months, but they only affect your score for 12 months.

Derogatory accounts stay on your credit report for seven years; most people are very clear on that fact. However, what many don’t know is that those accounts only affect their credit score for five years. So, while they’ll still be on the report for lenders and employers to see as history, they are not calculated into the scoring model to figure your score.

What kinds of actions hurt a credit score?

•    missing/late payments
•    credit cards at capacity (i.e. maxed out)
•    opening numerous new accounts in a short period of time
•    more revolving debt than installment
•    loans at finance companies

Missing and late payments are going to affect your score, period. You HAVE to pay your bills on time. Credit cards at max capacity means you aren’t managing your debt very well and are therefore a bit of a risk to potential lenders. On the flip side, though, having no debt on your credit cards can be just as bad. It is best, from a credit score standpoint, to keep your cards at 30-40% capacity.

Installment loans are better than revolving because there is a fixed period of time for which that money is borrowed and it reflects a better payment history. Loans at personal finance companies look bad on a credit report and they affect your score because these are the guys that will lend to anyone – usually those payday advance loans. They’re a sign of poor money management and looking for quick fixes to monetary problems.

What are things that lenders look for?

When lenders look at a credit report for consideration of a loan, there are many factors that go into their decision. While having a great credit score is no small feat, it’s also not enough to get a loan by itself. There are other factors that play a role in a lender’s decision. Some of these might include:

•    Income (and can you provide proof)
•    Employment history
•    Residential history
•    Repayment history (are you regularly late, or usually on time?)
•    Unsecured debt (do you have a lot of unsecured debt sitting out there?)
•    Revolving lines (do you have more revolving lines than installment, and how are they used?)
•    Loans with finance companies
•    Number of inquiries (a lot of recent inquiries could be a sign of desperation, which is often a sign of risk to a lender)
•    Number of new accounts
•    Relationship
•    Debt-to-income

Having some of these factors doesn’t necessarily mean that you’ll be declined or have a poor credit rating. For example, I have more revolving debt than installment loans. I have my car and that’s about it. But, I don’t have a lot of outstanding debt in general. I have three credit cards that I keep at 30-40% capacity. Now, having that one installment loan to three credit cards is probably why my score isn’t over 800, but that’s ok by my standards. Anything over 730 is considered top if the line and you’ll get any bank or credit union’s best rates.

When a lender considers your application for a loan, they are looking at how risky it would be to give you money. In other words, how likely are you to pay it back? Yes, they make money off the interest that you pay, but they only make that money if you pay it back. They also have to be fair and base their decision on facts retrieved from the credit bureau, so they rely very heavily on past performance history.

Keep an eye out for part three where I talk about home equity loans!

Related posts:

1. The Lending Game: Part 1
2. Get Low Rate Loans From Your Peers with Lending Club
3. What’s on your Credit Report?
4. Person-to-Person Online Lending
5. The New Face of FICO