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How do lenders determine who is approved for a credit card, mortgage, or car loan? Why are some individuals flooded with credit card offers while others get turned down routinely? Because creditors keep their evaluation standards secret, it is difficult to know just how to improve your credit rating. This Financial Guide explains how, and gives you a look into the practices of lenders and credit bureaus. Table of Contents
Credit Evaluation FactorsWhen you apply for a loan, how is your application processed? In some cases, such as applying for a loan from your bank, it may as simple as going to the bank, giving brief information about why you need a loan, signing a loan contract and getting a check immediately. Other banks use loan committees - a group of bank employees who decide which applications to approve. Still others use sophisticated, complex computer analysis to evaluate applications. Many creditors use credit scoring, in which point values are assigned to various credit characteristics. Those who get enough "points" get credit. Credit scoring can vary in complexity, according to the creditor's policy. Most creditors also have certain minimum requirements before they will consider an application. For instance, anyone who does not have a minimum annual income (perhaps $15,000) or who has been through bankruptcy may be summarily rejected. Most credit-scoring systems are more complicated than our example, with ten to thirty or more pieces of data to be analyzed for each applicant. With a more complex scoring system, a clerk enters information from both the credit application and the credit report onto a computer system, and the system evaluates it and produces an acceptance or rejection letter. Smaller creditors using simpler credit scoring have loans evaluated by a loan officer who makes the decision. By explaining what you need to make full use of your credit report, to determine your credit standing, and to maximize your chances for credit approval this Guide will help you to:
AgeIf a lender's credit experience shows that people in a certain age group have a better record of paying their bills than people of other ages, the lender may - legally - give a higher score to the better-paying age group. However, the Equal Credit Opportunity Act (ECOA), a federal law intended to prevent discrimination in lending, does not allow lenders to discriminate against people age 62 or over. The ECOA requires creditors using a scoring system to give those aged 62 and older an age-factor score at least as high as that given to anyone under age 62.
To prevent discrimination against older people, the lender must give anyone age 62 or older at least 6 points for age, since 6 points is the highest score available to anyone under 62 (i.e., those aged 25-35). ResidenceMany creditors give a higher score to those who have lived at the same address for at least two years. Some lenders just give extra points for living in the same area for two years or more. Creditors may take into account your geographic location in scoring your length of time at one address. If you live in a city, where people move more often, the length of time at your address will probably count less than if you live in the country. If your address is a post office box, you may find yourself turned down for credit. Also, to fight fraud, some creditors screen out applicants whose addresses indicate commercial offices, mail drops, or prisons. Since post office boxes or rural delivery boxes are commonplace in rural areas, however, a lender may issue a card to that address while rejecting applicants with a P.O. Box in a large city. People who own their homes earn a higher score than renters. "Authorized User" Payment HistoryAn authorized user is someone who has permission to use a credit card but is not legally liable for the bills. If you are an authorized user on someone's account, the payment history will likely be reported in your credit file, but you will not be able to rely on it to help you build your own credit rating. Usually, it will neither help you nor hurt you when you apply for a loan. Bank Card HistoryOne of the best things you can have on a credit report is a bankcard-a Visa, MasterCard or Discover card that has been paid on time over a period. In a scoring system, a good bankcard reference usually carries more weight than a department store card or American Express card. Department store charge cards have lower credit limits and if used will typically have a higher debt to limit ratio, which has a negative impact on credit scores. In addition, American Express is a charge card. As such users must pay in full, the amount due when the monthly statement arrives. There is no minimum payment, interest rate, or spending limit, and while American Express reports the high balance to credit bureaus, it doesn't impact FICO credit scores. The reason a bankcard is a strong reference is that it shows a bank has trusted you with hundreds or even thousands of dollars on the basis of just your signature. Also, bankcards are more difficult to get than department store cards or travel and entertainment cards, so your qualifications must have been closely scrutinized when you applied. Checking And Savings AccountsPeople who have checking and savings accounts usually score better than those who do not. Some banks give you extra points if you have checking or savings accounts with them. Some banks also give discounts on loan rates when you hold other accounts with them. BankruptcyMost lenders automatically reject anyone whose application or credit file indicates a bankruptcy. Chapter 13 in which (a debt reorganization plan under which all debts are eventually repaid) stays on credit reports until the debt is repaid plus an additional seven years. Chapter 7 (straight bankruptcy and partial or full liquidation of debts) remains on your credit files for ten years. Few creditors, however, draw any distinction between the two types, so you don't get any "credit" for having repaid your bills using Chapter 13. In addition to the bankruptcy itself remaining on your report for ten years, each separate account that was discharged through bankruptcy can be reported on your file for up to seven years. "Charge-Offs"Charge-offs, also called profit-and-loss accounts, are accounts that have been written off lenders' books as "uncollectible." If a charge-off account is not due to bankruptcy, the lender will usually turn it over to a collection agency, which will then attempt to collect. It then becomes a "collection account" (discussed below) for reporting purposes. Charge-off or collection accounts on a credit report are extremely negative.
Child consultingDelinquent child consulting frequently appears on credit reports. In 1984, Congress amended the federal Child consulting Enforcement (CSE) legislation to require more routine reporting of delinquent payments. State child consulting enforcement agencies must report overdue child consulting to a credit bureau that requests such information, as long as the amount exceeds $1,000. CSE agencies can also report delinquencies of any amount on a voluntary basis. Before a CSE agency reports your delinquent child consulting debts to a credit bureau, it must tell you that it is going to do so and provide you with information on how to dispute the delinquency. Closed Accounts And Inactive AccountsYou may be surprised to find you are turned down for a loan because you have too much credit available. Accounts you no longer use, or have paid off, can count against you if they are listed as "open" on a credit report. The act of paying off a revolving account does not, in itself, result in it's being "closed" in the eyes of lenders. Further, some creditors do not report to credit bureaus the fact that accounts are closed.
JobsLenders generally give more "points" to applicants who have been at the same job for two years or more.
Self-employed people, who often have a hard time getting credit, might try contacting the lender before applying to find out what additional information can improve your chances. Some lenders ask for copies of your business license, tax returns for the past years, or checking account statements to verify your cash flow. Collection Accounts And Charge-OffsCollection accounts are those that have been sent to collections by the creditor - either to the creditor's own collection department or an outside agency. Profit-and-loss accounts (also called charge-offs) are those the creditor decided could not be collected, and that were written off as a loss. Once a charge-off is sent to a collection agency or department, it turns into a collection account for reporting purposes. Collection accounts and profit-and-loss accounts are negative marks on credit reports. Should you pay a collection account? On the one hand, unpaid collection accounts can prevent you from getting other credit. On the other, some creditors reject anyone whose credit files list collection accounts or charge-offs-whether or not they have been paid. Collection accounts can legally remain on a report for seven years. They are reported to credit bureaus beginning on the date the collection agency received them from the creditor. Charge-offs (also called profit-and-loss accounts) are reported from the date they were charged off - the date the creditor decided the account was too far past due to get payment through normal channels and decided to close the account. Charged-off accounts are usually sent to a collection agency or the creditor's own collection department. The fact that delinquency (paying late) began before the account was placed for collection (or charged off) does not require the reporting date (the date the seven-year reporting begins) to be moved back, and the fact that payment was made after the account was placed for collection does not allow the date to be moved forward. If you do not pay a collection account, the lender may sue you. If the lender gets a legal judgment against you, the judgment can remain on your credit report seven years or more from the date the case was decided. In exchange for paying off a collection account, you may be able to negotiate with the creditor or collection agency the permanent removal of the negative information from your credit bureau files. Lenders are under no obligation to make such an agreement, however.
Cosigning An AccountYou may be asked to cosign an account to allow someone else to obtain a loan. With cosigning, your payment history and assets are used to qualify the cosigner for the loan.
Bear in mind that cosigning a loan bears all the financial and legal consequences of taking out the loan yourself. When you cosign, you are signing a contract that makes you responsible for the entire debt. If the other cosigner does not pay or makes late payments, it will probably show up on your credit record. If the person for whom you cosigned does not pay the loan, the collection company will be entitled to try to collect from you. If the cosigned loan is reported on your credit report, another lender will view the cosigned account as if it were your own debt. Further, if the information is correct, it will remain on your credit report for up to seven years.
Credit LimitsA credit limit is the maximum amount available to you from a certain lender. For example, a credit card issuer may grant you a credit limit of $1,000, meaning that once you charge $1,000, you will not be allowed to incur additional charges until you pay off some of your debt. When creditors evaluate your application for credit, they ascertain whether, if you were to use all your available credit, you would be over your head. They usually consider these factors:
Creditors may consider not only how much you currently owe, but also how much credit you have available. Having too much credit available can count against you. Also, being at or near the limit on your credit cards can count against you.
Obtaining Your Credit ReportsCredit reports are records of consumers' bill-paying habits collected, stored and sold by credit bureaus. Credit reports are also called credit records, credit files, and credit histories. The Fair Credit Reporting Act (FCRA) entitles each consumer to one free disclosure every 12 months. In addition, residents of CA, CO, CT, GA, ME, MD, MA, MN, MT, NJ, PR, VT, or VI, may be entitled to a free or reduced price personal credit report from each of the three major credit bureaus :
If you have been denied credit, employment, or insurance you can request that the credit bureau involved provide you with a free copy of your credit report, but you must request it promptly within 60 days. Request a copy through their websites or call the toll free telephone numbers provided. Debt/Income RatiosSome creditors look at your debt/income ratio-how much you pay out each month compared to how much income you earn-to determine whether you qualify for additional credit. To find your debt/income ratio, total up your monthly payments on all bills. Do not include mortgage, utilities, doctor bills or other accounts that do not appear on your credit report: The creditor will not look at these. Then, divide your total payments by your monthly gross (before tax) income. What results is your debt/income ratio. If it is less than 28%, you should have no trouble getting a loan. If it falls between 28 and 35%, you have what is considered high debt, and you may find it difficult to obtain some loans. If your debt/income ratio is 35% or more, you will probably not be able to get additional credit. More importantly, you are potentially in financial jeopardy. If you should incur unexpected expenses, get ill, lose your job, or get divorced, you could find yourself unable to meet your obligations. Consider seeking credit counseling through a local non-profit consumer credit counseling service. (Please see the listing at the end of this Guide.) This summary provides general guidelines. Some large card issuers will accept debt ratios as high as 40-45%. Others compare your net (after-tax) income to your debts to determine your debt ratio.
Department Store AccountsDepartment store cards do not provide as strong a reference on credit reports as bankcards. Not only are they easier to obtain, but the credit limits are low, and the "high credit" (the most you have ever charged) are low. Furthermore, you can use them only at the issuing store. Nevertheless, a timely paid department store card can help you develop a good credit history. Disputing Errors In Your Credit FileThe Fair Credit Reporting Act (FCRA) protects consumers in the case of inaccurate or incomplete information in credit files. The FCRA requires credit bureaus to investigate and correct any errors in your file.
Be aware that credit bureaus are not obligated to include all of your credit accounts in your report. If, for example, the credit union that holds your credit card account is not a paying subscriber of the credit bureau, the bureau is not obligated to add that reference to your file. Some may do so, however, for a small fee.
ECOA Designation CodesThe Equal Credit Opportunity Act (ECOA) requires creditors who report information about accounts to report it in the names of all people with a relationship to the account, including cosigners or authorized users. To help lenders identify your legal liability on all your credit accounts, credit bureaus add a code to each account, termed the ECOA code. Each credit bureau lists ECOA codes differently, but these are the basic categories:
Fair Credit Reporting Act (FCRA)This federal law was passed in 1970 to give consumers easier access to, and more information about, their credit files. The Fair Credit Reporting Act gives you the right to find out the information in your credit file, to dispute information you believe inaccurate or incomplete, and to find out who has seen your credit report in the past six months.
The Fair and Accurate Credit Transactions Act of 2003 (FACT or FACT Act)The Fair and Accurate Credit Transactions Act of 2003 (FACT or FACT Act) and is an amendment to the Fair Credit Reporting Act of 1970 and went into effect in December 2003. It was amended most recently in 2010 to include the provisions of the Consumer Financial Protection Act of 2010 (CFPA), which became effective on July 21, 2011, and the Red Flag Program Clarification Act of 2010. Consumers can now request and obtain a free credit report once every twelve months from each of the three nationwide consumer credit reporting companies (Equifax, Experian and TransUnion). In addition, the act also contains provisions relating to identity theft and fraud alerts, truncated credit and debit card numbers on non-manual receipts, and securely disposing of records containing consumer credit card information.
Finance Company Credit CardsMany systems actually score against people with one or more finance company accounts on their credit reports, since it appears to them that you had a hard time getting credit from traditional sources. There is a difference between "captive" finance trade-lines and "regular" finance trade-lines. Captive finance trade-lines are offered through auto financing sources such as GMAC or Ford Credit and are generally not considered negative.
Fraud"Application fraud" is when a thief uses your credit information to apply for credit in your name. Wrongdoers use your name, Social Security number, address and, perhaps, credit references to apply for credit. They can get much of this information from public sources (e.g., Who's Who Directories), from someone who has access to credit files (e.g., employees of car dealerships, department stores, or credit bureaus), from personal checks, or from stolen wallets. Credit thieves may be aided by "credit doctors" who are paid hundreds of dollars for finding a good credit record for the thief to use. Another form of application fraud involves the interception of pre-approved credit card offers in the mail. The thief fills out the application and either changes the address or steals the credit card out of your mailbox when it arrives at your address. You won't find out about application fraud until months after it occurs-usually only after you get dunning notices from collection agencies, or when you get a copy of your credit report and see the debts run up by the thief.
Income/Income Per DependentBe sure to list gross (before tax), not net (after tax), income on your loan application, unless the application asks for net income. Include income from a part-time job, public assistance or child consulting. The lender cannot discriminate against individuals with these sources of income in scoring an application. A creditor is permitted to determine whether that source of income is reliable. Some banks may approve loans for incomes as low as $10,000 per year. Others require higher income for some loans. Some banks will divide your income by the number of your dependents to determine your "income per dependent." If so, the application will ask how many dependents you have. InquiriesInquiries, which appear at the end of your credit report, tell you who has seen it recently. They are very important when you apply for credit. Lenders almost always look at how many inquiries you have when evaluating your application. Consumers with "too many inquiries" are often turned down, due to a concern that they are applying for too much credit at one time, that they are on a spending spree, or that there is potential fraud. Generally, a bankcard issuer wants no more than six inquiries in the past six months on an applicant's file. However, there is no set number for excessive inquiries, and every lender sets its own policy.
Lenders generally do not look at the sources of inquiries in counting them against the applicant. Thus, if you are applying for a car loan, you may think that only inquiries from car dealers will count against you, but in actuality all inquiries reported by credit bureaus are counted. If you have been shopping for a car loan and have several inquiries from auto dealers on your file, those inquiries could hurt your chances of getting a credit card. Or, if you have been trying to get a mortgage, you could find yourself unable to get a major credit card for several months because your credit report lists a number of inquiries from mortgage lenders
The consumer credit laws do not cover inquiries, so once they are on your file there is nothing you can do to have them removed. It is always worth trying to challenge inquiries with the credit bureau, but be aware that many credit bureaus refuse to investigate them. If you have too many inquiries, you may simply have to wait six months before applying for more credit. Inquiries generally stay on credit reports for two years. Some credit bureaus list inquiries by code, rather than by the name of the company. The Fair Credit Reporting Act requires that a credit bureau explain all information on your report that you do not understand, so request names for all the coded companies listed under the inquiries section. If an inquiry is coded "PRM" or "PSC," or has the word "promotional" next to it, then a lender has paid the credit bureau to screen suitable prospects for a "pre-approved" mailing. The lender supplies the bureau with a list of names and addresses and a set of credit criteria and asks the bureau to determine which candidates meet their criteria. The lender then receives from the credit bureau a list of the names that meet the qualifications, and those consumers receive a "pre-screened" or "pre-approved" credit offer. Inquiries noted as "csmr" or "consumer" indicate you have seen your own credit file. It is the policy of the major credit bureaus not to include promotional or consumer inquiries when transmitting the file to a lender, so review of your own file or pre-screening will not hurt your chances of getting credit.
Joint AccountsJoint accounts are those in which two or more people-usually spouses or members of a family-have equal responsibility for paying the bills. A joint account helps each person on the account build a credit history, but also has its pitfalls. If one person on a joint account does not pay the bills on time (and that payment history is reported to a credit bureau), the other party will likely find his or her credit history damaged. Joint accounts can be a problem in a divorce. Responsibility for paying off joint accounts is often assigned in the divorce decree or agreement. But regardless of how the judge allocates those bills, both spouses are legally responsible in the eyes of creditors. If any joint accounts remain open during or after the divorce and one spouse runs up bills and doesn't pay them, both spouses' credit histories will be harmed, since both are legally liable under the credit contract (spelled out in the card agreement or other papers). In addition, creditors have the right to try to collect from either spouse.
Late PaymentsRecent late payments - within the past six months or one year - are especially damaging to your credit record. Just one payment more than thirty days late in the past year can hurt your chances of getting credit. Late payments on bankcard accounts are usually the most damaging, since bankcards are such an important reference.
Length Of Credit HistoryMany people with no credit history find it nearly impossible to get a major credit card or, to a lesser extent, other credit. Scoring systems are not designed with the first-time credit user in mind. Bankcard issuers generally want to see at least a year's worth of timely payments on other accounts before issuing a card. If you do not have a credit record, you may have to smart small. You may want to start by getting a gasoline card. Chevron reports payments to the credit bureau monthly, while most other oil company cards do not. And get a few department store cards. Your best option for establishing a positive credit history may be a secured Visa or MasterCard. These credit cards are offered through bankcard issuers who have customers put up several hundred dollars in collateral in exchange for a card with a small credit limit. As you use the card, your bill-paying behavior is reported to a credit bureau and your credit history improves. Military Service PeopleThose in the military may find it difficult to get credit because they have a low income, move frequently, or do not have sufficient credit history. In addition, the fact that their wages cannot be garnished makes some creditors hesitate.
If you are having trouble getting a credit card because of a lack of credit history, you may want to try a secured credit card. MortgagesMost mortgages that are 90 days or more delinquent must now be reported to credit bureaus. Some mortgage companies elect to report all mortgages to credit bureaus. This policy is a plus for homeowners, since a mortgage can be a sign of stability to a lender.
Name/AliasIf you have a common name, or are a Jr. or Sr., you may find other people's information on your credit report. The credit bureaus say that there is not much they can do to prevent this mistake from occurring, so if you find this to be a problem, monitor your credit report carefully. Certainly, you should check it before you apply for a major loan or mortgage. An alias is another name for you on your credit report. It may be another name under which you have applied for credit (a nickname, or a variation of your name, for example) or it may be a name of someone else. It is possible, if an alias appears on your credit report, that actual fraud was involved. Someone else may have applied for credit using your qualifications and the name they used may have been entered as an alias. If you find an alias on your credit report, and it does not belong to you, contact the credit bureau immediately to have it removed. Negative InformationNegative information on a credit report is any information that may cause you to be turned down for credit or reduce your chances for loan approval. Negative information includes late payments, legal judgments, collection accounts, liens, and charge-offs. There is no way to remove negative information that is correct. If you paid any accounts that were charged-off, sent to collections, or for which the lender obtained a judgment against you, make sure these accounts are noted as paid. If any of these accounts remains unpaid, you are almost certain to be rejected for other loans. An unpaid collection account or judgment sends up a red flag to other creditors that the company to whom you owe the money could take further legal action against you, endangering your ability to pay other bills. Please see the section on "Collection Accounts" for further information. Do not be taken in by companies that, for a fee, offer to "fix bad credit" or "remove negative information" from credit reports. If it is possible to fix your bad credit, you can do it yourself, as long as you have the right information. You do not need to pay a fee to one of these companies to fix your credit problems. Number Of Credit AccountsCreditors want to see that you are able to handle credit over a period of time, and good credit references on your credit report help prove this ability. However, do not carry too much credit. Generally, if you have four or more bankcards, you are risking being turned down for "too many bankcards." Over The LimitGoing over the limit on your credit cards will often count against you. PaymentsIt does not matter if you pay your balance in full each month or just make minimum payments, as far as your payment rating is concerned, as long as you make at least your minimum monthly payment on time each month. While making only the minimum payments does not affect your payment record, you may have trouble getting credit if you are carrying high balances on most of your accounts. Previous Company ExperienceHaving had a previous loan with the lender to which you are applying can improve your chances of getting another loan there. Recent LoansJust as creditors do not want to see too many recent inquiries on a credit file, they do not want to see a number of recently opened loans, especially if you are new to credit. Revolving CreditRevolving credit means a line of credit. You are approved to borrow up to a certain limit, and you can draw upon all or part of that credit line whenever you choose. Your payments vary depending on the amount you have borrowed. Installment credit is a fixed amount of credit you borrow and agree to pay back on a fixed schedule. Your payments are the same each month. Revolving credit is a better reference than installment credit because applications for revolving credit are often scrutinized more carefully.
Putting An Explanation In Your Credit FileThe Fair Credit Reporting Act states that if you dispute information on your credit file that you believe to be inaccurate or incomplete, you can ask the credit bureau to investigate the problem. If the credit bureau's investigation does not resolve the dispute, you can file a brief statement explaining the nature of the dispute. Your statement becomes a permanent part of your file and will remain on the report as long as the negative information is reported. The credit bureau may limit your statement to one hundred words or less, but must help you summarize it if you ask them to do so. Some credit bureaus also allow you to add statement to your file explaining circumstances that led to the reporting of negative information to your file. For instance, if you fell behind on your bills for several months due to illness or a job lay-off, you may be able to add a short 100 word statement explaining the problem. If you do add a statement to your file, make it brief and factual. In general, if you provide a consumer statement that contains medical information related to service providers or medical procedures, then you expressly consent to including this information in every credit report issued for you.
Understanding Your Credit ReportCredit reports contain symbols and codes that are abstract to the average consumer. Every credit bureau report also includes a key that explains each code. Some of these keys decipher the information while others just cause more confusion. Read your report carefully, making a note of anything you do not understand. The credit bureau is required by law to provide trained personnel to explain it to you. If accounts are identified by code number, or if there is a creditor listed on the report that you do not recognize, ask the credit bureau to supply you with the name and location of the creditor so you can ascertain if you do indeed hold an account with that creditor. If the report includes accounts that you do not believe are yours, it is extremely important to find out why they are listed on your report. It is possible they are the accounts of a relative or someone with a name similar to yours. Less likely, but more importantly, someone may have used your credit information to apply for credit in your name. This type of fraud can cause a great deal of damage to your credit report, so investigate the unknown account as thoroughly as possible. It is vital that you understand every piece of information on your credit report in order that you be able to identify possible errors or omissions.
Government and Non-Profit AgenciesThe following agencies are responsible for enforcing federal laws that govern credit card transactions and may be a good resource in the event you believe that there is incorrect information on your credit report. Questions concerning a particular card issuer should be directed to the enforcement agency responsible for that issuer.
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