Monitoring Your Credit

For easy reference, all credit score and credit report information is now available in one place:

Your credit score is used by banks to estimate your financial reliability and to decide the terms under which they will lend you money (1).  The credit reporting agencies, chief among them Experian, Equifax, and TransUnion, compile information on your credit history and prepare a numerical credit score and credit report (2,3,4).  When you apply for a credit card, the bank purchases your credit information from one of these agencies and uses the information in them to decide whether to approve or deny your application and how to set your credit limit.
The largest US credit bureau is a $4.5 billion public company

Innovis and PRBC are two smaller credit bureaus that have begun to gain prominence (5,6).  PRBC is seeking to collect data on repeating rent, bill, and loan payments to build profiles of consumers with little to no traditional credit history, who may be a good credit risk but are chronically underserved by the current credit scoring system.

Score Factors

The standard Fair Isaac Corporation credit score (FICO score) is on a 550-point scale from 300-850 (7).  While the actual FICO score equations are secret, FICO has disclosed the score breakdown (8):

  1. Payment History (35%) on-time every time is better
  2. Credit Utilization Ratio (30%) lower is better
  3. Credit Age (15%) older is better
  4. Types of Credit (10%) more types (installment, revolving, consumer finance, mortgage) is better
  5. Recent Credit Searches (10%) fewer credit inquiries is better

Unsurprisingly, your past payment reliability is a huge part of your credit score and credit report.  If you pay your existing credit cards and other loans on time every month, a bank will conjecture that you are likely to pay as agreed on any new credit they extend you.  If you've declared bankruptcy and absolved your commercial debts in court... you're likely not a very good risk.

Your credit utilization ratio is nearly as important as your credit history.  Your credit utilization ratio is the sum of your credit limit on all of your credit cards, divided by the average amount of money you charge to your cards each month.  Potential lenders like to see that you have plenty of credit that you don't use; otherwise, they worry you will max out your new credit beyond your ability to pay.

If you use all of the credit available to you, this reduces your credit score - the optimal credit utilization ratio has been estimated to be as low as 12%.  For every $1000 you spend on a credit card each month, $8000 in revolving credit would give you the optimal ratio.  The Internet also abounds with stories of individuals with perfect credit - a numerical score of 850 - who have dozens of credit cards and hundreds of thousands of dollars in revolving credit.  An extra card or two certainly won't kill you... in fact, it will likely help.

Credit age takes into account the years that your oldest account has been open and the average age of all of your credit accounts.  An old credit card account will remain on your credit report for up to 10 years after you close it, but it's best to keep your oldest account open forever to preserve the longest possible credit age.

When a bank requests your credit report, record of this 'hard pull' will remain on your credit report for 2 years and may reduce your FICO score for one year.  If you're in school and not planning on any big loans in the near future, this might not matter, but you should hold off of applying for credit for one year before applying for a home mortgage or car loan.

Requesting Your Report

You may request your credit report for free once per year from each of the three largest credit bureaus (9).  You can request all three reports at once, or space them out over the year - it's up to you!  The report will include ongoing payment status information on all of your credit accounts, any complaints lodged against you by your creditors, and a log of what companies have requested your credit report.

In the process of requesting your free reports, the credit bureaus will try to sell you credit monitoring services and lots of other junk.  Don't be fooled into buying anything.

It's useful to check up on your report for a variety of reasons:

  1. See what the banks see.  When you're on the market for more credit, whether it's a new cashback credit card or a mortgage, it's useful to know where you stand so that you have realistic expectations about the interest rates and terms they will likely extend to you.
  2. Spot identity theft.  If someone else has opened an account under your name, you'll see it here.
  3. Correct errors.  The FTC says that at least a quarter of credit reports contain inaccuracies (10); if yours is one of them, whether it's a falsely-reported late payment or an incorrect address, you can file a dispute with the credit bureau and get this taken care of.
  4. Take out the trash.  Remember that one time in college, when you filled out a credit card application for a free burrito?  You probably don't, but your credit report will allow you to see any old accounts you still have lying around that might be candidates for updating or closing.  Keep in mind that your credit age is an important positive factor in your credit score, so avoid closing your oldest credit card if you can help it.

Requesting your credit report doesn't affect your credit score in any way.

Requesting Your Score

If you are ever denied credit, the bank is required to give you information about your score and the specific reasons you were denied.  Your numerical credit score usually costs ~$12 from each credit bureau, but free services like CreditSesame can get you your FICO score, updated monthly, for free.

(1) http://en.wikipedia.org/wiki/Credit_bureau
(2) http://en.wikipedia.org/wiki/Experian
(3) http://en.wikipedia.org/wiki/Equifax
(4) http://en.wikipedia.org/wiki/TransUnion
(5) http://en.wikipedia.org/wiki/Innovis
(6) http://en.wikipedia.org/wiki/PRBC
(7) http://en.wikipedia.org/wiki/Credit_score_in_the_United_States
(8) http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx
(9) https://www.annualcreditreport.com/
(10) http://www.forbes.com/sites/moneybuilder/2013/02/19/ftc-says-26-of-credit-reports-have-errors/