For many, credit is the thing that represents their ability to borrow. But credit is much more than that. It signifies a person's reputation as a borrower, comprised of information about past behavior that attempts to predict future behavior when it comes to borrowing. In short, an individual's credit is made up of his or her borrowing history and is used to tell lenders how likely it is that person will repay a loan. The bottom line to good credit is showing lenders you are an experienced, responsible borrower.
Personal information in regards to someone's borrowing history is gathered together in a credit report by a credit bureau. Various lenders provide information to these bureaus which show how much an individual has borrowed and how they paid back the loan. While originally credit was used by lenders to assist them in making borrowing decisions, today it is used in a variety of ways. An individual's diminished credit scores have even been known to affect that person's ability to land a new job.
To understand how lenders view you in regards to credit, it's first important to understand how credit scores work. These scores indicate to lenders the likeliness that a person may default on a loan. Rather than trying to sort through pages of someone's credit history, a score number is assigned. A computer program generates these numbers based on its analysis of how a person has repaid their loans in the past. Score numbers range from 300 to 850 with the higher numbers indicating a good to excellent score and mid- to lower numbers representing someone who would be considered a credit risk.
The most common credit score is generated from the Fair Isaac Corporation (FICO). The corporation examines an individual's credit report and then determines a credit score using the following formula:
35% payment history
30% amounts owed
15% length of credit
10% new credit
10% type of credit
What's important to note here is that the credit score is only as good as the credit report which created it. If personal information is out of date or incorrect, it could affect the assigned score. To ensure the information on a credit report is correct, a free government credit report is available to any individual so it can be checked for inaccuracies. All U.S. consumers are entitled to this free report once a year, as required by the federal Fair Credit Reporting Act (FCRA). This helps to make certain that consumers are informed about what their credit report says about them and to fight any incidences of identity theft.
After a person has reviewed their credit report, if any mistakes are found, that individual should gather evidence that will prove a credit agency needs to make a correction to the report. Copies of documents that prove the report is inaccurate should be included along with a letter on how the report should be fixed. The letter should clearly outline the creditor's name and details of the account in question and specifics on the inaccuracy. Individuals should also include a full name, address, date of birth and Social Security Number. Legitimate claims must be investigated and the credit report fixed within 30 days. An individual reporting an error will be informed of the results.
It's also a good idea to safeguard your credit by sending duplicates of this information to the creditor who reported the error. Make sure to check back in several weeks on the status of the situation.
Understanding credit is an essential key to establishing creditworthiness as a consumer. To focus on improving one's credit score, consider a few of these guidelines:
1. Pay on time
2. Get current on past-due accounts
3. Communicate with a lender if there are difficulties making an on-time payment
4. Keep balances at 35% or lower relative to the credit limit
5. Have a variety of loan types, such as a car loan, mortgage and a few credit cards to demonstrate experience as a borrower.