by Nick Gromicko, CMI®
If you apply for a loan to buy a house, the lender is going to decide whether you are a good or poor credit risk based on your credit report. If the report says that you have a lot of debt, or you don't pay your bills on time, the lender may adjust your interest rate accordingly – or deny you the loan altogether. Thus, a good credit report can be as helpful to the home-buying process as an InterNACHI inspection, so it’s best if you understand how these reports work.
Where do credit reports come from?
A company that gathers and sells credit information is called a credit bureau. There are more than 1,000 local and regional credit bureaus countrywide that gather information about your credit habits directly from your creditors. These smaller bureaus transfer their data to three large, national credit bureaus: Equifax, Experian and TransUnion.
Who may want to see your credit report?
Those interested in your credit report include:
- government agencies reviewing your financial status for government benefits;
- insurers, while they consider you for an insurance policy;
- anyone with a legitimate business need for the information, such as a potential landlord;
- creditors who are considering granting or have granted you credit; and
employers considering you for employment, promotion or reassignment (although some states, including Colorado, have introduced legislation to prohibit this practice).
Court orders or subpoenas may be filed to gain access to a credit report. Any third party may receive your credit report if you request this in writing.
- What type of information is contained in a credit report?
- personal identifying information, including your full name, any known aliases, current and previous addresses, Social Security number, birth date, telephone number, current and previous employers, and, if applicable, similar information about your spouse;
- credit history, which includes your bill-paying history with banks, utilities, retail stores, finance companies, mortgage companies, and anyone else who has granted you credit. Specifically included is information about when you opened each account, the account type, how much credit was extended, your monthly payment, payment patterns, and missed payments;
- public records, which may indicate your credit-worthiness, such as tax liens, bankruptcies and court judgments;
- credit report inquiries, which is a list of all creditors who have requested a copy of your credit report; and
- dispute statements, which are any statements you've made disputing information on the report.
Note that credit reports don’t include bank account balances, race, religion, health status or history, driving record, income, or criminal record.
- What in the report will make you appear to be a poor credit risk?
- maxed-out credit lines. These look bad because they indicate that you may be financially strapped;
- high debt-to-income ratio. If your credit card debt is greater than 20% of your income, it might scare the prospective lender;
- missed payments. For obvious reasons, your payment history is a major consideration when you are seeking a loan; and
- bankruptcy. Unlike all other credit information, which reaches back seven years, bankruptcies stay on your report for 10 years.
- Might the report contain inaccurate information?
Typos, out-of-date information, and even mistaken identity can crop up on your credit report just as easily as a misspelled address on your mail. Credit report errors can be very serious, since they may unfairly jeopardize your chances of being approved for a loan for a house or another important expense. If you believe you’ve found an error, you should contact the credit bureau immediately, and they will have up to 45 days to fix the error.
- How do you obtain a copy of your credit report?
Legally, you are entitled to receive one free credit report every 12 months from each of the three nationwide consumer credit-reporting companies. They will need basic personal information in order to verify your identity. Beware of predatory companies -- many of them operated by the major credit bureaus themselves – that charge service fees for credit reports.
- How is a credit score different from a credit report?
The credit score formula was developed by Fair, Isaac and Company (FICO) in order to easily represent all of the information in your credit report in a single number. This score, which is not included in the credit report, allows lenders to predict the likelihood that you will pay back the loan and make timely payments. FICO’s credit score ranges from 300 to 850, and is calculated using the following formula:
- payment history = 35%;
- debt ratio = 30%;
- length of credit history = 15%;
- types of credit = 10%; and
- number of credit inquiries = 10%.
Tips for Improving Your Credit Report
- Close the accounts you don't use, as they indicate to a potential lender that you could easily put yourself into financial danger with so much readily available credit. Do not merely destroy the credit card; call or write the card company to cancel the account.
- Don’t close out your oldest card, as it has the longest credit history.
- Get a copy of your report before you apply for a loan to avoid any unwelcome surprises.
- Always make at least the minimum payment each month, or you’ll be haunted by red flags for seven years.
- Reduce your debt-to-income ratio and you'll be able to get better rates on the loans you seek.
- You can move some of the debt from a maxed-out card to other cards, if you have them.
In summary, credit reports contain information that can make or break your chances of being approved for a home loan.