How Credit Monitoring Works

First, an important clarification: Credit monitoring is not the same as credit reporting.

Credit reporting agencies collect information about your credit history and share it with potential creditors. All of your credit cards, home mortgages, car loans and other lines of credit are listed on your credit report along with your payment history. Every time you apply for a new loan or credit card, the creditor requests a copy of your credit report from one or all of the "Big Three" agencies: Equifax, Experian and TransUnion. These same credit reporting agencies also calculate your official credit score using their own variation on a formula developed by a company called FICO.

Credit monitoring services alert you to changes in the reports and scores generated by credit reporting agencies. To make things even more confusing, all of the "Big Three" credit reporting agencies also offer credit monitoring services.

What exactly do you get if you sign up for a credit monitoring service? You will receive email or text alerts when any of the following changes occur on your credit report [source: Creditreport.com]:

In terms of identity theft, the biggest threat is someone opening a new credit account in your name. New account fraud is harder to fix than standard credit card fraud and can get expensive, too. As we mentioned earlier, only a small percentage of identity theft victims in 2013 had to pay out-of-pocket for fraudulent charges. But for those that did, victims of new account fraud paid an average of $449 compared to $108 for existing account fraud [source: Blyskal].

There are some financial benefits to credit monitoring. For example, most credit monitoring services include an option to track your credit score. The higher your credit score, the more likely you are to get a better interest rate on loans or lines of credit, which will save you money in the long run. Credit monitoring services can offer insight into the factors that influence your score and tips for improving your score over time. Experian's credit monitoring service even includes a simulator that predicts the impact of new loans — mortgages, car loans, etc. — on your score [source: Experian].

Some defenders of credit monitoring argue that the educational value of the services alone justifies their price. Simply being aware of the way your spending and borrowing habits affect your score can lead to higher scores (if you change your behavior) and ultimately save you thousands of dollars in lower interest payments [source: Khalfani-Cox].

Now let's look at what the critics say about the value of credit monitoring services.

The first gripe that many consumer advocates have with credit monitoring services is the misleading way they've been sold to the public. The most notable culprit is Experian, the credit reporting agency behind the controversial website FreeCreditReport.com.

Back in 2003, Congress passed the Fair Credit Reporting Act requiring each of the "Big Three" credit reporting agencies to provide consumers with a free copy of their credit report once a year [source: FTC]. The problem was that Experian already owned the URL FreeCreditReport.com and refused to sell it to the government.

The government ended up creating AnnualCreditReport.com for public access to the legally mandated free credit reports, but Experian continued to siphon away consumers with its misleading website. It turns out that the "free" credit report it offered was only free for seven days, after which consumers were charged $14.95 a month for a credit monitoring service if they failed to cancel. Experian ended up paying the Federal Trade Commission $1.25 million to settle charges of false advertising [source: Lieber].

Besides their misleading sales tactics, credit monitoring companies are criticized for marketing their services as effective protections against identity theft. Credit monitoring alerts can only give you a clue that identity theft has already taken place — like the creation of an unauthorized new credit account or a change of address — not protect you against the crime in the first place [source: Weston].

A larger criticism of credit monitoring services is that daily monitoring of your credit status is simply unnecessary. Consumers don't stand to gain financially from knowing that their credit score rose or fell two points from one day to the next. Such short-term fluctuations are impossible to evaluate given that it's unclear what formula the credit monitoring company is using to calculate the score [source: Weston]. Also, a constant stream of alerts may make it more likely that you skip over a warning that your account actually has been breached.

Then there's the issue of single-report credit monitoring versus three-report monitoring. In the case of Target and its massive identity theft case, it offered victims free access to credit monitoring from Experian, but not TransUnion or Equifax. Not all creditors report data to all three agencies, so monitoring only one report is less effective [source: Blyskal].

Perhaps the most glaring criticism of credit monitoring services is that consumers can protect themselves just as well — perhaps better — for free. We'll explain how on the next page.

Credit monitoring services are worth the price in specific situations. As we mentioned, victims of identity theft would definitely benefit from credit monitoring to make sure that thieves don't try to open accounts in their name or reroute existing accounts to a new address. But for the average consumer, it's possible to protect your credit and your identity using freely available online tools.

For starters, take advantage of the three free credit reports offered through AnnualCreditReport.com. Instead of ordering all three at once, send away for one every four months [source: Weston]. You won't get a complete picture each time — remember, not all creditors report to every agency — but it will give you three free chances to spot potential issues.

Since the vast majority of "identity theft" is really credit card theft, check your credit card statements regularly for unauthorized purchases. Contact the credit card company immediately if you suspect that your card number has been compromised. You should also sign up for online access to your bank account and self-monitor your account balances for unexpected debits or transfers.

If you are the victim of identity theft, or suspect foul play, you can contact any one of the three credit reporting agencies and ask for a 90-day fraud alert on all of your accounts (each agency is required by law to notify the other two). The fraud alert is free and prevents anyone from opening a new credit account without calling you and confirming the transaction [source: FTC].

If that's not enough, you can further tighten your credit security by issuing a credit freeze on your accounts. A credit freeze is like a lockdown on your credit report. You can still request free annual copies of the report and do things like apply for a job or a mortgage, but lenders can't access the report unless you temporarily lift the freeze [source: FTC]. Unlike fraud alerts, credit freezes are not always free, depending on where you live.

If you really want to see your credit score (not included in the free report from AnnualCreditReport.com), you can buy it at myFICO.com for $14.95, but read the fine print. Your purchase, of course, will automatically sign you up for monthly credit monitoring.

For lots more information about credit, debt and protecting yourself against identity theft, check out the related links that follow.