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F.A.R.E. Debt Education

F.A.R.E.’s mission is to provide exceptional debt education, to ensure financial independence, foster financial responsibility and to improve the quality of life for the betterment of society

Before you start the next module, let’s do a quick review.

In Module One, we discussed Maslow’s Hierarchy of Needs.

We continued that discussion in a Guide to Better Budgeting. Along with identifying how and why we spend the way we do, we also discussed:

  • The importance of having a spending plan or budget
  • What areas should be included in a spending plan
  • How to maintain the spending plan once it is developed

In the next module, we take a closer look at credit, credit scores, and what it takes to have and/or maintain good credit.

Objectives

Upon completion of the module you will:

  • Learn the history of Credit Scoring.
  • Understand how Credit Scoring and Credit Ratings work for and against you.
  • Learn what information is on a credit report and how long it will be there.
  • Learn why errors occur on your credit report and how to correct them.
  • Learn about the connection between FICO® Scores and Credit Grades.

Credit Scoring – What’s it all about?

Wondering, just what are FICO® scores and where they came from?

FICO® scores are the credit scores most lenders use to determine your credit risk. You have three scores, one for each of the three credit bureaus:

  • Experian, www.experian.com
  • TransUnion, www.transunion.com
  • Equifax, www.equifax.com

The concept was created by a California-based company, Fair Isaac and Company.

How do you benefit from credit scoring?

  • Allows for speedy, objective analysis of credit histories.
  • Scores are objective because they are based on large volumes of verified statistical data. Credit scoring brings a new level of fairness to the credit granting process.
  • With credit scoring, lending decisions are likely to be more objective, faster and less costly than traditional ‘judgmental’ decisions. Additional benefits include “greater consistency in lending decisions. 1

1 From testimony presented before the House Banking and Financial Services Committee’s Subcommittee on Financial Institutions and Consumer Credit by the Federal Trade Commission

What is a Credit Rating and where does it come from?

A credit rating measures credit worthiness. Credit ratings are calculated from financial history, current assets, and liabilities.

A good rating helps you reach financial goals; a poor rating limits your financial opportunities, indicates a high risk of defaulting on a loan, thus leading to high interest rates.

Your credit rating is drawn from your credit report, the credit report outlines your borrowing, charging, and repayment activities. Credit reports can be obtained from one of the three major Credit Reporting Agencies (CRA), who each also have different name for your FICO® score.

Credit Reporting Agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations.

The three major Credit Reporting Agencies (CRA) are:

  • Equifax – Usually the lowest score (BEACON®)
  • Experian – Usually the middle score (Experian/Experian/Fair Isaac Risk Model)
  • TransUnion – Usually the highest score (EMPIRICA®)

Why are my three credit scores so different?

According to The Fair Isaac Company , the company responsible for creating the credit score concept, this is why:

“…here’s why your FICO scores may in fact be different at the three credit reporting agencies. The way lenders and other businesses report information to the credit reporting agencies sometimes results in different information being in your credit report at the three agencies. The agencies may also report the same information in different ways. Even small differences in the information at the three credit reporting agencies can affect your scores.”

Taken from the booklet “Understanding Your Credit Score.” by The Fair Isaac Company. This booklet is available for free at http://www.myfico.com/Downloads/Brochures.aspx

Credit Report: How Long Can Information Be Reported?

Accurate positive information can remain on your credit report forever.

Accurate negative information can remain on your credit report for only seven years, with a couple of exceptions:

  • A bankruptcy (10 years)
  • A judgment (7 years or until the statute of limitations runs which ever is longer)

Debts can be reported even if you paid the debt in full before the end of the allowed reporting time period.

As far as accurate negative information, there is no legal way to remove it other than time.

The date on which the seven year reporting period begins depends on whether the creditor first reported the account to a credit reporting agency before or after December 29, 1997.

  • Reported Prior to 12-29-97
    • Regular Accounts – Time starts when the bill is due. For example, if a bill was due October 1, 1996 and you did not pay it until December 15, 1996, the seven-year reporting period begins October 1, 1996.
    • Collection and charge-off accounts – Can be reported for seven years from the date the merchant charged-off the account or placed for collection.
  • Reported After 12-29-97
    • All Accounts – No more than seven years and six months from the date the debt should have been paid.

What does a Credit Report Look Like?

creditreportkey1

You are allowed one free report from any of the three Credit Reporting Agency (CRA) annually.

You can also get your report free from www.annualreport.com. However, it will not have your credit score.

You can pay for an additional report from the CRA online or by regular mail.

Credit Scoring – What’s it all about?

What factors influence your FICO® scores?

There are five categories found to be most predictive and they are:

  • (35%) Payment History
  • (30%) Credit Utilization
  • (15%) Credit History
  • (10%) Type of Credit
  • (10%) Inquiries

creditChart

My FICO scores?

How do your FICO® scores translate into Credit Grades?

Here is where the scoring systems really get personal. The scores drive the credit grades which determine the rate of interest you will pay. The higher your scores/grade the lower your rate. The lower your scores/grade the higher your rate.

Your Credit Rating: A Quick Guide to Credit Grade

In this table you will find an example of how lenders divide the spectrum of credit scores into ranges e.g. 720+ = A+ or 551-580 = B. Every lender develops their own matrix with corresponding rates and terms.

CreditScoreGrid

Credit Reports Errors

How Do Errors in Reports Happen?

Think about how often your mail has a misspelling of your name or a mistake in your street address. Then, imagine the possibility for error in a report that contains much more information about you. Cases of mistaken identity, out-of-date information, and outright errors can easily occur.

How Do You Correct an Error on Your Credit Report?

Contact the consumer credit reporting agency immediately. The company is then responsible for researching and changing or removing incorrect data. This process may take as long as 45 days. At your request, a corrected report will be sent to those parties that you specify who have received your report within the past six months, or employers who have received it within the last two years.

Tell the CRA in writing. Your letter should include:

  • complete name and address
  • each item in your report you dispute
  • an explanation of why you dispute the information and request deletion or correction
  • an enclosed copy of the report with the item in question circled

Send your letter by certified mail, returned receipt requested, so you can document what the CRA received.

Summary

In this module we learned:

  • The FICO® score was created by the California based company Fair Isaac
  • The purpose of Credit scoring is to provide the consumer with an objective and measurable means of evaluating their credit worthiness. It also allowed for greater consistency , objectivity, and quicker loan decisions from creditors.
  • FICO® scores are objective and credit scoring brings a new level of fairness to the credit granting process.
  • How Credit Reporting Agencies (CRA), credit ratings, and poor credit ratings impact interest rates and ultimately the credit we get.
  • How long and what type of information is kept on our credit report.
  • What factors influence our FICO® scores.
  • What are credit grades and what factors determine them.
  • How to correct errors on our credit report.

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