A Credit Primer: Credit Reports and Scores Made Simple

Don’t wait until a collection agency comes calling to get serious about your credit. Here are some of the basics to know.

Read more from our #PERSONALFINANCE primer here.

My credit was once so bad I couldn’t get a cell phone plan. One dumb decision—skipping out on a hospital bill even though I had medical insurance that would have covered it—snowballed into a financial crisis. Now, after cleaning up my credit report and changing my financial habits, my credit score is in the high 700s (out of a possible 850) Trust me: life is better with good credit.

You can eke by with a low credit score, but just barely. When you have bad credit, you feel like you’re pressed against a fence with the life you want to live on the other side. Bad credit not only makes everything more expensive, it limits your choices in housing, transportation and even employment. Landlords check credit before offering leases. Banks check credit to set mortgages. Bad credit jacks up auto insurance rates. Most maddening, in light of your desperate need for money, bad credit can keep you from getting a job as an increasing number of employers pull credit reports prior to making hiring decisions.

But let’s back away from the ledge. Your credit score is not a reflection of your character. It’s a numerical representation of your credit risk formulated from your loan repayment history. It’s how institutions hedge their bets: for them, scores take some of the guesswork out of lending you money. Every loan, from a credit card to a mortgage, entails some degree of risk, but when a borrower has a history of paying their debts on time, the risk seems lower. A credit score rates your debt payment record, assigning it a number between 300 and 850 (like the SATs, there’s no such thing as a starting point of zero) so lenders can assess your creditworthiness at a glance.

FICO Scores and What They Mean 

There are several credit rating systems but the most common one is FICO, which stands for Fair Isaac & Company, the corporation behind the famous scores. A FICO score is a credit score developed through FICO’s “predictive analytics,” which involves analyzing information collected from credit reporting agencies to predict likely outcomes for lending money. FICO isn’t the only credit rating system, but it’s the most widely used, so generally, the terms FICO score and credit score are used interchangeably.

Good credit (i.e., a high credit score) indicates you have been trustworthy with money in the past, and gives you access to more credit at a better rate. Bad credit or lack of credit (a low credit score) means lenders have reasons to doubt how trustworthy you are, so they offset the risk by charging a higher interest rate to make more money from the payments they do receive. That’s why having bad credit means you have to pay more for everything.

FICO takes five factors into account when they tabulate their scores.

  • Payment History: Do you pay your bills on time? It’s a simple but critical question that accounts for 35 percent of your credit score.
  • Credit Utilization: The amount of credit you use counts for 30 percent of your FICO score. For example, if you owe $2,000 to each of four cards with $2,500 limits, the $8,000 you owe on the $10,000 total of your credit line represents 80 percent of your available credit. That’s a dangerous utilization ratio, incidentally—Nerdwallet recommends keeping it under 30 percent.
  • Age of Credit Accounts: Lenders like people with long histories of on-time payments. The length of time you’ve had an account open forms 15 percent of your score.
  • Recent Credit Inquiries: If you found out that someone you know had been asking around to borrow money, you’d probably assume he or she was in a financial hole. Lenders use the same reasoning and count credit background checks for 10 percent of credit scores.
  • Types of Credit: Lenders like to see a mix of borrowing (and repayment); a variety of credit (for instance, a student loan, a credit card and rent or mortgage payments) makes up 10 percent of your credit score. Having just one credit card, for instance, or a student loan can bring your score down.

The Three Credit Reporting Bureaus

The best way to begin proactively improving your credit is by getting copies of your credit reports. There are three major credit reporting bureaus: TransUnion, Experian and Equifax. All three release their own credit reports (and scores), which consist of compiled detailed accounts of your debt repayment history. Like the Gospels, each credit agency’s report tells the same story, just in a slightly different way. For instance, various lenders and companies partner with different credit reporting agencies, so while all are keeping tabs on your track record, the sources vary. One credit card company might work with Experian while a department store or online retailer may use TransUnion. All three reports can have different information (and FICO assigns a score to each credit report), which is why you’ll want to get copies from all three bureaus.

Besides your credit card history, your credit report will have information about payments on mortgages, student loans, or car loans. Delinquent payments can appear on your credit report if the lender reports it to a debt collector. Types of delinquent payments include overdue utility bills, unpaid medical expenses (like my emergency room visit) and owed rent. Unfortunately for those with good payment histories, credit reports only note that information when it’s a problem. Your stellar record paying your cable bill doesn’t earn you bonus points.

You’re legally entitled to receive a free copy of all three credit reports every 12 months. Despite what the annoying TV jingles say about free credit reports, there’s only one federal government approved site to get them: annualcreditreport.com. The other credit reporting services are not only annoying commercial creators, many are scams and rip-offs.

Cleaning Up Your Credit

When you pull your credit reports, scrutinize them carefully. Here’s a handy checklist of what to look for. Mistakes can occur for a number of reasons: perhaps you used your nickname on a credit application (Rob versus Robert) or maybe a lender transposed two digits on your social security number, or dropped a letter from your last name. Also, payments occasionally get applied to the wrong account. Any of those mistakes could be costing you money. A 2012 FTC survey found that 20 percent of people who pulled their reports found an error, and that five percent of respondents had errors serious enough to hurt their credit. In my case, when I pulled my credit report a decade ago, a cell phone company claimed I was delinquent on an account I never signed up for.

If you find mistakes, or something looks fishy, don’t panic. And don’t bother with credit repair services either. As the experts at credit.com advise, the services aren’t able to do anything you can’t do yourself. Contesting a charge isn’t complicated but it does require time and close attention. If you notice something screwy, crack your knuckles and turn on the printer. You’ve got some letters to write. Following these guidelines and sample letters from the FTC, send letters and copies (not originals) of supportive documentation to each of the agencies reporting the error and the originator of the claim.

Fixing your credit report can involve an introduction to an exquisitely unpleasant type of professional service: debt collection agencies. Sometimes lenders give up on collecting a loan and sell the debt. The collection agencies that buy loans aren’t shy about getting in touch. Expect phone calls, letters and little regard for your excuses. Thankfully, you have options. If they contact you in error, send a certified letter (sample letter here) saying you don’t owe them money. If they prove the debt is legit, Bankrate.com advises negotiating. They may accept a smaller amount than you owe or agree to delete the account from your credit report.

Boosting your credit won’t happen overnight. If there are no messes to clean up and you’re just looking to bump up your score, keep up the good work of making timely payments, and be patient. Fixing bad credit means changing your habits and waiting for lenders to notice. Barring the unlikely event that money falls out of the sky and onto your lap, it takes some time and discipline to claw your way out of a credit quagmire. But knowing that you’re taking an active role in polishing up your creditworthiness can pump you up. You’ve got a stretch of road ahead of you, but you’ve started to run.