When you apply for a loan, how is your application processed? In some cases, such as applying for a loan from your bank, it may be as simple as going to the bank, giving brief information about why you need a loan, signing a loan contract and getting a check immediately. Other banks use loan committees – a group of bank employees who decide which applications to approve. Still others use sophisticated, complex computer analysis to evaluate applications.
Many creditors use credit scoring, in which point values are assigned to various credit characteristics. Those who get enough “points” get credit. Credit scoring can vary in complexity, according to the creditor’s policy.
Most creditors also have certain minimum requirements before they will consider an application. For instance, anyone who does not have a minimum annual income (perhaps $15,000) or who has been through bankruptcy may be summarily rejected.
Most credit-scoring systems are more complicated than the example used here, with ten to thirty or more pieces of data to be analyzed for each applicant. With a more complex scoring system, a clerk enters information from both the credit application and the credit report onto a computer system, and the system evaluates it and produces an acceptance or rejection letter. Smaller creditors using simpler credit scoring have loans evaluated by a loan officer who makes the decision.
By explaining what you need to make full use of your credit report, to determine your credit standing, and to maximize your chances for credit approval this Guide will help you to:
- Better understand your credit report,
- Know the meaning of jargon used in the credit industry, and
- Find out exactly what you can do to improve your credit standing.
Age
If a lender’s credit experience shows that people in a certain age group have a better record of paying their bills than people of other ages, the lender may – legally – give a higher score to the better-paying age group.
However, the Equal Credit Opportunity Act (ECOA), a federal law intended to prevent discrimination in lending, does not allow lenders to discriminate against people age 62 or over. The ECOA requires creditors using a scoring system to give those aged 62 and older an age-factor score at least as high as that given to anyone under age 62.
A lender gives the following age scores to applicants:
| Age: |
# Points |
| 18-25 |
2 points |
| 25-35 |
6 points |
| 35-45 |
4 points |
| 45 or more |
3 points |
| 62 or more |
6 points |
To prevent discrimination against older people, the lender must give anyone age 62 or older at least 6 points for age, since 6 points is the highest score available to anyone under 62 (i.e., those aged 25-35).
Residence
Many creditors give a higher score to those who have lived at the same address for at least two years. Some lenders just give extra points for living in the same area for two years or more.
Creditors may take into account your geographic location in scoring your length of time at one address. If you live in a city, where people move more often, the length of time at your address will probably count less than if you live in the country.
If your address is a post office box, you may find yourself turned down for credit. Also, to fight fraud, some creditors screen out applicants whose addresses indicate commercial offices, mail drops, or prisons. Since post office boxes or rural delivery boxes are commonplace in rural areas, however, a lender may issue a card to that address while rejecting applicants with a P.O. Box in a large city.
People who own their homes earn a higher score than renters.
“Authorized User” Payment History
An authorized user is someone who has permission to use a credit card but is not legally liable for the bills. If you are an authorized user on someone’s account, the payment history will likely be reported in your credit file, but you will not be able to rely on it to help you build your own credit rating. Usually, it will neither help you nor hurt you when you apply for a loan.
Bank Card History
One of the best things you can have on a credit report is a bankcard (e.g., a Visa, MasterCard or Discover card) that has been paid on time over a period. In a scoring system, a good bankcard reference usually carries more weight than a department store card or American Express card. Department store charge cards have lower credit limits and if used will typically have a higher debt to limit ratio, which has a negative impact on credit scores. In addition, American Express is a charge card. As such users must pay in full, the amount due when the monthly statement arrives. There is no minimum payment, interest rate, or spending limit, and while American Express reports the high balance to credit bureaus, it doesn’t impact FICO credit scores.
The reason a bankcard is a strong reference is that it shows a bank has trusted you with hundreds or even thousands of dollars on the basis of just your signature. Also, bankcards are more difficult to get than department store cards or travel and entertainment cards, so your qualifications must have been closely scrutinized when you applied.
Checking And Savings Accounts
People who have checking and savings accounts usually score better than those who do not. Some banks give you extra points if you have checking or savings accounts with them. Some banks also give discounts on loan rates when you hold other accounts with them.
Debt/Income Ratios
Some creditors look at your debt/income ratio how much you pay out each month compared to how much income you earn to determine whether you qualify for additional credit.
To find your debt/income ratio, total up your monthly payments on all bills. Do not include mortgage, utilities, doctor bills or other accounts that do not appear on your credit report: The creditor will not look at these. Then, divide your total payments by your monthly gross (before tax) income. What results is your debt to income ratio. If it is less than 28 percent, you should have no trouble getting a loan. If it falls between 28 and 35 percent, you have what is considered high debt, and you may find it difficult to obtain some loans.
If your debt/income ratio is 35 percent or more, you will probably not be able to get additional credit. More importantly, you are potentially in financial jeopardy. If you should incur unexpected expenses, get ill, lose your job, or get divorced, you could find yourself unable to meet your obligations. Consider seeking credit counseling through a local non-profit consumer credit counseling service. (Please see the listing at the end of this Guide.)
This summary provides general guidelines. Some large card issuers will accept debt ratios as high as 40-45 percent. Others compare your net (after-tax) income to your debts to determine your debt ratio.
If you keep your debt ratio below 28 percent, you can consider yourself successful at managing your debt and maintaining a good credit rating.
Department Store Accounts
Department store cards do not provide as strong a reference on credit reports as bankcards. Not only are they easier to obtain, but the credit limits are low, and the “high credit” (the most you have ever charged) are low. Furthermore, you can use them only at the issuing store. Nevertheless, a timely paid department store card can help you develop a good credit history.
Disputing Errors In Your Credit File
The Fair Credit Reporting Act (FCRA) protects consumers in the case of inaccurate or incomplete information in credit files. The FCRA requires credit bureaus to investigate and correct any errors in your file.
If you find any incorrect or incomplete information in your file, write to the credit bureau and ask them to investigate the information. Under the FCRA, they have about thirty days to contact the creditor and find out whether the information is correct. If not, it will be deleted.
Be aware that credit bureaus are not obligated to include all of your credit accounts in your report. If, for example, the credit union that holds your credit card account is not a paying subscriber of the credit bureau, the bureau is not obligated to add that reference to your file. Some may do so, however, for a small fee.
Bankruptcy
Most lenders automatically reject anyone whose application or credit file indicates a bankruptcy. Chapter 13 in which (a debt reorganization plan under which all debts are eventually repaid) stays on credit reports until the debt is repaid plus an additional seven years. Chapter 7 (straight bankruptcy and partial or full liquidation of debts) remains on your credit files for ten years. Few creditors, however, draw any distinction between the two types, so you don’t get any “credit” for having repaid your bills using Chapter 13.
In addition to the bankruptcy itself remaining on your report for ten years, each separate account that was discharged through bankruptcy can be reported on your file for up to seven years.
Child Support
Delinquent child support frequently appears on credit reports. In 1984, Congress amended the federal Child Support Enforcement (CSE) legislation to require more routine reporting of delinquent payments. State child support enforcement agencies must report overdue child support to a credit bureau that requests such information, as long as the amount exceeds $1,000. CSE agencies can also report delinquencies of any amount on a voluntary basis.
Before a CSE agency reports your delinquent child support debts to a credit bureau, it must tell you that it is going to do so and provide you with information on how to dispute the delinquency.
Closed Accounts And Inactive Accounts
You may be surprised to find you are turned down for a loan because you have too much credit available. Accounts you no longer use, or have paid off, can count against you if they are listed as “open” on a credit report.
The act of paying off a revolving account does not, in itself, result in it’s being “closed” in the eyes of lenders. Further, some creditors do not report to credit bureaus the fact that accounts are closed.
If a closed account appears on your credit report as open, dispute the entry with the credit bureau. The Fair Reporting Act gives consumers the right to dispute any information in their credit file they believe inaccurate or incomplete. Explain to the credit bureau that you would like the report to reflect the account as closed. It is also a good idea to send a certified letter to the creditor requesting that the entry is corrected with all the credit bureaus to which it has been reported.
Every time you close an account, ask the creditor to report it as “closed by consumer” to all Credit Bureaus to which the account has previously been reported. Make this request in writing, and ask for written confirmation that it has been done. If you have trouble getting confirmation from customer service representatives, ask to speak with a credit manager. Be sure to comply with the lender’s procedures for closing the account, such as returning credit cards or unused credit line checks. Your cardholder agreement will have those instructions.
Employment
Lenders generally give more “points” to applicants who have been at the same job for two years or more. Self-employed people, who often have a hard time getting credit, might try contacting the lender before applying to find out what additional information can improve your chances. Some lenders ask for copies of your business license, tax returns for the past years, or checking account statements to verify your cash flow.
If you have changed jobs recently, indicate on your application whether you have stayed in the same field, since some lenders will consider the length of time in your field if the length of time in your job is not sufficient.
Collection Accounts And Charge-Offs
Collection accounts are those that have been sent to collections by the creditor – either to the creditor’s own collection department or an outside agency. Profit-and-loss accounts (also called charge-offs) are those the creditor decided could not be collected, and that were written off as a loss. Once a charge-off is sent to a collection agency or department, it turns into a collection account for reporting purposes. Collection accounts and profit-and-loss accounts are negative marks on credit reports.
Should you pay a collection account? On the one hand, unpaid collection accounts can prevent you from getting other credit. On the other hand, some creditors reject anyone whose credit files list collection accounts or charge-offs-whether or not they have been paid.
Collection accounts can legally remain on a report for seven years. They are reported to credit bureaus beginning on the date the collection agency received them from the creditor.
Charge-offs, also called profit-and-loss accounts, are accounts that have been written off lenders’ books as “uncollectible.” If a charge-off account is not due to bankruptcy, the lender will usually turn it over to a collection agency, which will then attempt to collect. It then becomes a “collection account” (discussed below) for reporting purposes. Charge-offs are reported from the date they were charged off – the date the creditor decided the account was too far past due to get payment through normal channels and decided to close the account.
Charge-off or collection accounts on a credit report are extremely negative. If you pay the charge-off via the collection agency, make sure the lender updates the account as a “paid charge-off.”
The fact that delinquency (paying late) began before the account was placed for collection (or charged off) does not require the reporting date (the date the seven-year reporting begins) to be moved back, and the fact that payment was made after the account was placed for collection does not allow the date to be moved forward.
If you do not pay a collection account, the lender may sue you. If the lender gets a legal judgment against you, the judgment can remain on your credit report seven years or more from the date the case was decided.
In exchange for paying off a collection account, you may be able to negotiate with the creditor or collection agency the permanent removal of the negative information from your credit bureau files. Lenders are under no obligation to make such an agreement, however.
Late Payments
Recent late payments – within the past six months or one year – are especially damaging to your credit record. Just one payment more than thirty days late in the past year can hurt your chances of getting credit. Late payments on bankcard accounts are usually the most damaging since bankcards are such an important reference.
Be sure to get the minimum payment in the mail on time each month. As far as your payment rating (R-l, R-2 or I-l, I-2, etc.), it makes no difference whether your monthly payment is the minimum or a large payment. Just the minimum on time will keep your rating in good shape.
There’s one exception: If you are near your credit limits on most or all of your accounts, you may be considered a poor credit risk whether or not you pay on time. See the section on “Credit Limits for further discussion.
Length Of Credit History
Many people with no credit history find it nearly impossible to get a major credit card or, to a lesser extent, other credit. Scoring systems are not designed with the first-time credit user in mind.
Bankcard issuers generally want to see at least a year’s worth of timely payments on other accounts before issuing a card.
If you do not have a credit record, you may have to smart small. You may want to start by getting a gasoline card. Chevron reports payments to the credit bureau monthly, while most other oil company cards do not. And get a few department store cards.
Your best option for establishing a positive credit history may be a secured Visa or MasterCard. These credit cards are offered through bankcard issuers who have customers put up several hundred dollars in collateral in exchange for a card with a small credit limit. As you use the card, your bill-paying behavior is reported to a credit bureau and your credit history improves.
Military Service People
Those in the military may find it difficult to get credit because they have a low income, move frequently, or do not have sufficient credit history. In addition, the fact that their wages cannot be garnished makes some creditors hesitate.
One of the main reasons people in the military cannot get credit cards is the fraud associated with APO boxes. If you are in the military, live overseas, and are applying for a credit card, list your stateside address, your parents’ address, or a P.O. box, instead of an APO.
If you are having trouble getting a credit card because of a lack of credit history, you may want to try a secured credit card.
Mortgages
Most mortgages that are 90 days or more delinquent must now be reported to credit bureaus. Some mortgage companies elect to report all mortgages to credit bureaus. This policy is a plus for homeowners since a mortgage can be a sign of stability to a lender.
Never pay your mortgage late. If your mortgage has a grace period (e.g., “Payment due January 1. After January 10, late charges will be assessed.”), do not take this to mean you can pay between January 1 and January 10. If you pay after the first due date, your payment will probably be considered late, and the late payment will appear on your credit report.
Negative Information
Negative information on a credit report is any information that may cause you to be turned down for credit or reduce your chances for loan approval. Negative information includes late payments, legal judgments, collection accounts, liens, and charge-offs.
There is no way to remove negative information that is correct. If you paid any accounts that were charged-off, sent to collections, or for which the lender obtained a judgment against you, make sure these accounts are noted as paid. If any of these accounts remains unpaid, you are almost certain to be rejected for other loans. An unpaid collection account or judgment sends up a red flag to other creditors that the company to whom you owe the money could take further legal action against you, endangering your ability to pay other bills. Please see the section on “Collection Accounts” for further information.
Do not be taken in by companies that, for a fee, offer to “fix bad credit” or “remove negative information” from credit reports. If it is possible to fix your bad credit, you can do it yourself, as long as you have the right information. You do not need to pay a fee to one of these companies to fix your credit problems.
Number Of Credit Accounts
Creditors want to see that you are able to handle credit over a period of time, and good credit references on your credit report help prove this ability. However, do not carry too much credit. Generally, if you have four or more bankcards, you are risking being turned down for “too many bankcards.”
Over The Limit
Going over the limit on your credit cards will often count against you.
Payments
It does not matter if you pay your balance in full each month or just make minimum payments, as far as your payment rating is concerned, as long as you make at least your minimum monthly payment on time each month.
While making only the minimum payments does not affect your payment record, you may have trouble getting credit if you are carrying high balances on most of your accounts.
Previous Company Experience
Having had a previous loan with the lender to which you are applying can improve your chances of getting another loan there.
Recent Loans
Just as creditors do not want to see too many recent inquiries on a credit file, they do not want to see a number of recently opened loans, especially if you are new to credit.
Revolving Credit
Revolving credit means a line of credit. You are approved to borrow up to a certain limit, and you can draw upon all or part of that credit line whenever you choose. Your payments vary depending on the amount you have borrowed.
Installment credit is a fixed amount of credit you borrow and agree to pay back on a fixed schedule. Your payments are the same each month.
Revolving credit is a better reference than installment credit because applications for revolving credit are often scrutinized more carefully.
Buy Now, Pay Later (BNPL)
Starting in 2022, the three major credit bureaus (Equifax, Experian, and TransUnion) will add information to consumer credit reports from companies such as Affirm, Klarna, and Afterpay that offer buy now, pay later (BNPL) loans. Missing payments or taking on too many of these “short-term” loans could cause your credit score to drop.
Income/Income Per Dependent
Be sure to list gross (before tax), not net (after tax), income on your loan application, unless the application asks for net income. Include income from a part-time job, public assistance or child support. The lender cannot discriminate against individuals with these sources of income in scoring an application. A creditor is permitted to determine whether that source of income is reliable.
Some banks may approve loans for incomes as low as $10,000 per year. Others require higher income for some loans. Some banks will divide your income by the number of your dependents to determine your “income per dependent.” If so, the application will ask how many dependents you have.
Inquiries
Inquiries, which appear at the end of your credit report, tell you who has seen it recently. They are very important when you apply for credit. Lenders almost always look at how many inquiries you have when evaluating your application. Consumers with “too many inquiries” are often turned down, due to a concern that they are applying for too much credit at one time, that they are on a spending spree, or that there is potential fraud.
Generally, a bankcard issuer wants no more than six inquiries in the past six months on an applicant’s file. However, there is no set number for excessive inquiries, and every lender sets its own policy.
Apply only for credit you really want, and wait for a response on each application before applying elsewhere.
Lenders generally do not look at the sources of inquiries in counting them against the applicant. Thus, if you are applying for a car loan, you may think that only inquiries from car dealers will count against you, but in actuality all inquiries reported by credit bureaus are counted. If you have been shopping for a car loan and have several inquiries from auto dealers on your file, those inquiries could hurt your chances of getting a credit card. Or, if you have been trying to get a mortgage, you could find yourself unable to get a major credit card for several months because your credit report lists a number of inquiries from mortgage lenders
Auto dealers often look at customers’ credit files without their knowledge or permission. If you go to a dealership to test drive a car, the salesperson will often pull up your credit file, and use the information in deciding how to “sell” you. It is important to tell the salesperson that you do not want your credit file accessed unless you give permission.
The consumer credit laws do not cover inquiries, so once they are on your file there is nothing you can do to have them removed. It is always worth trying to challenge inquiries with the credit bureau, but be aware that many credit bureaus refuse to investigate them. If you have too many inquiries, you may simply have to wait six months before applying for more credit. Inquiries generally stay on credit reports for two years.
Some credit bureaus list inquiries by code, rather than by the name of the company. The Fair Credit Reporting Act requires that a credit bureau explains all information on your report that you do not understand, so request names for all the coded companies listed under the inquiries section.
If an inquiry is coded “PRM” or “PSC,” or has the word “promotional” next to it, then a lender has paid the credit bureau to screen suitable prospects for a “preapproved” mailing. The lender supplies the bureau with a list of names and addresses and a set of credit criteria and asks the bureau to determine which candidates meet their criteria. The lender then receives from the credit bureau a list of the names that meet the qualifications, and those consumers receive a “prescreened” or “preapproved” credit offer.
Inquiries noted as “csmr” or “consumer” indicate you have seen your own credit file.
It is the policy of the major credit bureaus not to include promotional or consumer inquiries when transmitting the file to a lender, so review of your own file or prescreening will not hurt your chances of getting credit.
