Gaining a clear understanding about credit scores and credit reports can be difficult, and this lack of clarity is not accidental. The companies that issue credit scores do not share the formula they use to generate the score, which is one reason why people are so often confused about credit scores and credit reports, and do not know which is most important.
Credit Report
A credit report tracks information about you that creditors can use to determine your creditworthiness. The main components of a report are:
- Identifying information. Your name, birth date, Social Security number, address and employment history are all vital components of your credit report, as they distinguish you from others. However, none of this information is used to determine your credit worthiness.
- Public records and collections. Your credit report will contain state and county court records, including judgments, liens, foreclosures and bankruptcies.
- Credit accounts. These are sometimes called “Trade Lines” and are a list provided by creditors of every account you have opened, including mortgages, car loans, credit cards and store charge cards. The date the account was opened, the amount of your credit line, current balance and your payment history are all included on the report.
- Credit inquiries. Every time a lender requests a copy of your credit report, they will be added to a list on your credit report and will stay there for two years. These include “soft inquiries,” which occur when a lender requests your credit report for marketing purposes, and “hard inquiries,” which occur when you apply for a loan or credit card.
Equifax, Experian and Transunion are the three major consumer credit bureaus, and each has a credit report for most consumers. When you apply for a line of credit or a loan, creditors will likely request a copy of your report. A credit report may also be a part of a pre-employment background check. Consumers are legally entitled to a free copy of their credit report every year, which they can request through a number of avenues, including AnnualCreditReport.com.
Credit Score
Before credit scores, whenever someone applied for a line of credit, lenders would request a copy of the applicant’s credit report and would read the entire document to make a credit decision. Since it required considerable time and skill to review and interpret these reports, creditors decided to begin using credit scores in lieu of the full reports.
A credit score is a number that represents an applicant’s creditworthiness. It is created by a proprietary formula that takes into account all of the information on a person’s credit report. Several companies offer credit scores, and each company offers more than one formula to lenders. A credit score can range from 300 to 850. Finally, the score can originate from data collected from any of the three credit bureaus, so consumers can have several different scores, depending on the report and scoring formula used.
As mentioned earlier, the exact formula that is used to determine your credit score is not disclosed, as it is proprietary information. However, the FICO consumer credit score is made up of the following factors:
- Payment history (35%)
- Amounts owed (30%)
- Credit history length (15%)
- New credit accounts (10%)
- Credit mix (10%)
Credit scores are only used to determine the creditworthiness of loan applicants. They are not used for pre-employment screenings.
Which is more important?
Since your credit score is based upon your credit report, they are linked. However, they are used for different purposes. If you are applying for a revolving credit account, including credit cards and store cards, it is likely the issuer will only request your credit score. This is why credit scores were created in the first place–so creditors could make a fast determination of your creditworthiness instead of examining your credit report.
However, in a few other cases, creditors will want to see the credit report. If you are applying for a major loans, such as a car loan or mortgage, lenders will request copies of your credit report from one or more of the consumer credit bureaus. Creditors will want to see details about your payment records, debt levels and account histories. They will be particularly interested in public records, including liens, judgments and bankruptcies.
Since your credit report is vital to certain loans and provides the data for your credit score, it is imperative that you check your report for accuracy and dispute any inaccurate information. You will also want to keep an eye on your credit score, as this can alert you to issues with your credit report. In fact, many credit card issuers now offer cardholders free monthly credit scores.
While credit reports and credit scores are not the most fun or exciting things to deal with, they are an important part of our financial system. When you understand the difference and similarities between the two, you will understand important components of your credit, and you can make sure to take the necessary steps to maximize your chances of being approved for a new line of credit or loan.