All anyone ever seems to focus on when talking about credit is the score. A good score. A bad score. My score went up so I'm thrilled. My score went down. Why? A preoccupation with arguably the least important factor when determining credit worthiness. At its core, credit worthiness is measure of a consumer's confidence, or rather, the level of confidence in the consumer whether they will pay back money borrowed from a bank, credit union, or other lending institution, and how. Credit worthiness starts with one's credit report, not the score. This is because the score is based on the underlying model, is based on the report. In this article we'll explore what each component represents and its significance.
Let's start with credit reports - the foundation of credit worthiness. Credit reports are a collection of one's demographic data like full name, birth year, and recent addresses - typically three. If reported, past employers might be included. They also contain reported credit accounts, the account's use, and current standing - positive or negative. Experience dictates most credit accounts are often only reported to two of the three major credit bureaus in the United States. Experian, Equifax, and Transunion. In certain instances, such as with a late payment, some creditors will begin reporting the late payment to one or both other bureaus, even if previously not reporting use of the account to that bureau. For example, a credit card offered through a major bank reports overall credit limit, rolling balance, and timeliness of payments to both Experian & Transunion. If the cardholder misses a payment and the account is reported as '30 Days Late', the bank may then begin to report use of the account to Experian also. This is one of many reasons why it is important to pay the minimum balance on credit cards and other debt obligations if at all possible. That initial negative hit to one's credit file can be a slippery slope which if left unaddressed, can lead to long-standing negative items requiring months or even years to remove.
Layout and naming conventions vary depending on the source of the credit report. However, generally speaking, a report will contain data for the following classifications:
Demographic Data
Hard Inquiries
Public Records
Charge-off / Collection Accounts
Foreclosures / Short Sales
Current Delinquencies
Sometimes data such as charge-offs, collections, or foreclosures are not listed in specific sections, but are noted when viewing the additional details of a particular account. For example, a credit card account closed in good standing might say something like Past Due - Current, Last Reported - Account has been closed or Closed or paid according to... where the full comment indicates the account was paid according to the original terms. An unpaid account sent to collections might say Last Reported - Subject has not satisfied payment terms. In the future we will provide a more in-depth guide on how to read reports.
Score models are exactly as they sound. They are formulas used to calculate a credit score based on the information contained in a credit report. This is why scores can vary so widely depending on the source. Speaking from experience, creditors and credit bureaus tend to use less forgiving models when calculating scores. What does this mean? Technically speaking, FICO, an abbreviation of the Fair Isaac Corporation, has credit score models going all the way out to FICO Score 10T. As of August, 2024 on Experian's website, however, the model used to provide a score is based on the FICO Score 8. FICO Score 8 negatively scores unpaid general collections and medical collections, whereas newer iterations such as 9, 10, or 10T generally disregard paid collections and medical debt, either paid or unpaid, when calculating a credit score. This means for someone with an unexpected hospital bill they couldn't afford to pay and a credit card sent to collections that was paid in full, their score would be significantly higher using a newer versus an older model. In future posts, we will explore the two major scoring models, FICO and Vantage, and the percentage break-down for each component used to generate a credit score.
That brings us to the most focused on credit component, credit score. The primary focus of most anyone discussing credit. In simplest terms, a credit score is an at-a-glance representation of one's credit worthiness. When applying for credit, having a high enough score is often all that's required to receive an instant approval. This is because lenders are nearly always running credit applications through back-end systems that require certain criteria to be met for approval. The decision is usually instantaneous. With little exception, if you apply for credit at a physical location such as a bank, if the bank representative tells you that your file is under review and you'll receive a letter in the mail - that is a denial. Company policy prohibits that representative from directly delivering the bad news. In some instances, an applicant can request a manual re-evaluation and even provide any comments they think might help their case to the underwriter - the person ultimately responsible for providing an approval or denial to the applicant. It may not change the initial computer-based decision but could be worth the applicant's time if receiving that credit is absolutely necessary.
While each of these topics will be explored in greater detail in future articles, to the extent appropriate, I encourage you, the reader, to perform your own research and strengthen your own understanding of these topics. Now a social media sensation, Robert Kiyosaki, American author of Rich Dad, Poor Dad and real estate mogul, repeatedly states in his content that, "Credit doesn't matter..." When dealing with millions, or hundreds of millions of dollars worth of investment properties, yes, you have successfully graduated to a level beyond credit. The lending institution will be looking at proven, responsible management practices and the ability to satisfy debt agreements far more than they care about your FICO or Vantage scores. The rest of us mortals must still worry about credit. Good luck out there.
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