Credit Scores and Credit Ratings, Intelligent Credit Management, Establishing or Re-establishing a Credit History

In the United States and Canada, like nowhere else, establishing a credit history for the first time, or re-establishing after some poor personal credit management, is a difficult process. The problem comes that you need a history before you can get credit but cannot establish a history without getting credit. It is a classical "Catch-22" situation!

Loan, mortgage companies and other financial institutions pay professional credit bureaus to compile information about individual consumers. The reports are like a sort of high school report cards on the person or a company, where credit bureaus rate a persons behavior in the financial world by collecting individual credit and payment information.

What are the components of the Credit Score?

The engineer Fair Isaac, and mathematician Earl Isaac, developed and launched the FICO Scores (FICO stands as an abbreviation for their company - Fair Isaac Company, which still owns the licensing rights, and charges a fee for the use of the method), in 1956, as a measure of credit risk This measure is now the most used credit score in Canada and the USA.

The credit scores can range from 300 to 950. Though, the most relevant range is to about 850.

The Credit Scores

The scores classify individuals into certain categories which are then evaluated by lenders and now, commonly also by employers, on the basis shown below.

750+	Excellent	You might get credit at a discount
720-749	Very Good	Credit at normal loan conditions; maybe even at a discount
620-719	Good	Normal loan conditions will apply
580-619	Low Score	Lenders are willing to extend credit but at a higher cost in terms of interest as well as through additional fees
500-579	Poor Credit, High Risk	You are judged a poor risk in the credit market and this will reflect itself in an even higher interest rate and fees. If the credit market is tight you might have some difficulties in getting credit. For mortgages, the lender maybe asks for a higher down payment.
below 499	In Need of Credit Repair	You have a serious credit problem. You might want to consult debt consolidation or credit counseling.

There are several relevant credit monitoring agencies in the USA and they will assess you differently. The three main credit monitoring agencies are Equinox, Experian and TransUnion. There are two more, Innovis and PRBC, but they are of minor importance.

All credit agencies use FICO scores as the basis of their evaluation. The three main ones include additional measures, sometimes between 10 and 20 different characteristics, giving them different weights within the total calculation. As a consequence, you will have differing scores from the three main agencies.The differences will not be large, but 20 or 40 points can make quite a difference, to the way a lender views your credit worthiness.

The Parts of the FICO Credit Score Components and their Weight within the Total Score

Strangely enough, the amount or level of income the person has does not play any part in the credit score. The argument of the credit score compilers is that quantity alone, does not guarantee good credit behavior or even lower risk to a potential lender.

35%	Payment History	Your payment history and that you pay your credit obligations on time are the key components in assessing your credit risk.
30%	Amounts owed in Relation to your total Credit Lines	Different clients have different credit capacities. The key in this measure, however, is how much of your credit capacity you have used! If you want to have a good credit score, do not use more than 30-35% of your individual credit lines.
15%	Length of time of the Credit Relationships	Banks and financial institutions value stable long term relationships highly. The more solid your relationship with your bank or other financial institutions, the higher your credit score.
10%	New and Recent Credit Lines	When you look for new credit, make your search short, since long credit searches raise a flag with analysts, implying that you have been turned down repeatedly and are, therefore, a poor credit risk!
10%	Types of Credit	The types of credit you have obtained is important. Do not rely solely on credit cards, since they are expensive money and a credit analyst seeing this on your credit report will classify you as an unsophisticated financial operator. Similarly, car loans and installment credit with regular payments are rated higher than bank credit lines.

However, in a loan evaluation, the amount of your income does play a part. Your income will be related to the total amount of your debt and to your outgoings in servicing this debt. It is just that for the calculation resulting in your credit score, income is not seen as important.

You can get a free credit score once a year from all three credit reporting agencies under the Fair Credit Reporting Act, from http://www.annualcreditreport.com .

Once you have the credit report, examine it for accounts that are noted as delinquent, if you have any such accounts. Also, check out how many of your accounts show late payments. Both types of incidences will lower your credit score.

The rules under which these credit bureaus work are governed by the Federal Trade Commission. The following public document will give some insight:

How Valid is the Credit Scoring System?

With credit scoring systems, creditors are able to evaluate millions of applicants consistently and impartially on the basis of different characteristics. But credit scoring systems must be based on large enough numbers of recent accounts to make them statistically valid.

Although you may think that such a system is arbitrary or impersonal, a properly developed credit market using a credit scoring system can make decisions faster and more accurately than an non systematic individual approach can. And some lenders, especially if they have experience with you, design their systems so that marginal cases -- not high enough to pass easily or low enough to fail definitively -- are referred to a credit manager who personally decides whether the company will extend credit to that consumer. This may allow for discussion and negotiation between the loan manager and the potential borrower.

What Happens If You Are Denied Credit?

While a creditor is not required to tell you the factors and points used in its scoring system, the creditor must tell you why you were rejected for credit. This is required under the Equal Credit Opportunity Act (ECOA).

So if, for example, a creditor says you were denied credit because you have not worked at your current job long enough, you might want to reapply after you have been at that job longer. Or, if you were denied credit because your debt-free monthly-income was not high enough, you might want to pay some of your bills and reapply. Remember, also, that credit scoring systems differ from creditor to creditor, so you might get credit if you applied for it elsewhere.

Sometimes you can be denied credit because of a bad credit report. If so, the Fair Credit Reporting Act requires the creditor to give you the name and address of the credit reporting bureau that reported the information. You might want to contact that credit bureau to find out what your credit report said. This information is free if you request it within 30 days of being turned down for credit. Remember that the credit bureau can tell you what is in your report, but only the creditor can tell you, why it denied your application. If you are denied credit, you still have some alternatives.

One possibility is to find another lender who might be willing to take a risk with you, but at a price. So you have to carefully weigh, how far you want to go with that.

Another option is to have someone, a relative for instance, who has a good credit history established co-sign. If you are lucky enough to know such a person, you are on your way to establishing credit. But you have to realize the responsibility you take on and that any default of credit on your part affects the credit history and credit score of the co-signer. Therefore, you have to evaluate your own credit risk carefully. Someone who cares about you to co-sign, certainly does not deserve a bad credit record through no fault of their own.

Once the co-signing has been done, you make payments on or before the due date. Over time, you will have established a credit history. If you want to accelerate the issue, payoff the debt in full when the first bill arrives but not before. Completion of the full billing cycle is important for a "pays on time" report card to be established.

You might have to repeat this until you no longer need the co-signor. A good credit history is now again established.