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How Credit Reports Work


How Lenders Interpret Your Credit Report

As mentioned on the previous page, your credit report only relays the history of your dealings with creditors. However, you need to look closely. There's information there that may seem innocent to you but not to potential creditors. This includes information like:

  • Inquiries - Every time you apply for a credit card to get a free travel mug, duffel bag, or T-shirt, you are adding another hard inquiry to your credit report. When potential lenders see these inquiries, it may wrongly imply that you're either in some financial situation where you need a lot of credit, or are planning to take on a large debt. Either can flag you as a high credit risk. Other types of inquiries, such as your own requests to view the report, employer requests to view the report and requests by marketers to get your name in order to sell you something, count as soft inquiries. These inquiries don't show up on the reports that lenders see, and therefore don't affect how they view your credit. Also, watch out when you are car shopping or mortgage shopping. Make sure you don't let the car dealer or mortgage broker run your credit unless you know you're going to be buying from them. While the FCRA allows these types of multiple credit inquiries that are within seven to 14 days of each other to be counted as a single inquiry, you would have to be careful of your timing to make sure you don't have multiple inquiries show up. So, how many hard inquiries can you have without a problem? Some experts say that if you have 10 credit card inquiries in six months, that will probably scare a lender. Others experts say that as few as six credit card inquiries in six months can label you as risky. Inquiries that are older than six months may not be looked at as strongly because if you actually set up the loan or opened the credit card account, those accounts would now be showing up on your report as well. The newer inquiries might lead the lender to think that you actually have the credit accounts available now but they haven't shown up on the credit report yet. Most inquiries drop off of your report after two years.
  • Open credit accounts - Another thing to watch out for as you gather all of those free mugs and duffel bags is that even though you may have forgotten about them, accounts you don't use still count toward your total available credit. Just as with the hard inquiries we've talked about, these can indicate to a potential lender that you could easily put yourself into financial danger with all of that readily available credit. According to TransUnion and Experian, you should not close out your oldest card, because it has the most history on it; also, you should maintain four to six credit cards to "keep your credit score and debt balances healthy" [source: TransUnion]. But other than that, close the accounts you don't use. In addition to avoiding excessive available credit, you're limiting your exposure to identity theft. Cutting up the card or just not using it doesn't mean the account is closed. You have to call or write to the card company and ask to close the account.
  • Missed payments - Obviously, your payment history makes a big difference. You should always make at least the minimum payment, or consolidate accounts to reduce your payments. These delinquencies stay on your report for seven years -- even if you've caught up your payments! The same goes for accounts that creditors have turned over to collection agencies or charged-off -- meaning that they've written the account off as a loss. Even if you do pay off the account at a later date, the charge-off or collection action stays on your report for seven years.
  • Maxed-out credit lines - Another thing that scares lenders is a maxed-out credit line (or two). This waves a big red flag and indicates that you may be financially strapped for some reason. Some experts suggest moving debt around if this is the case. For example, if you have a maxed-out card but have other cards that haven't reached their credit limits, you might consider moving some of the debt from the maxed-out card to the non-maxed-out ones.
  • Debt in relation to income - If you have unsecured credit card debt that is more than 20 percent of your annual income, lenders may not want to give you the best deal on a loan -- if they'll take the chance and give you a loan in the first place. Work to reduce the debt-to-income ratio and you'll be able to get better rates on the loans you seek.

Now, let's look at how you and others can access your credit report.