One of the little-known facts about the credit industry is that lenders treat your credit report as a running scorecard of your financial life.
When you apply for a credit card, auto loan, or mortgage, lenders take your credit report and run it through a mathematical program called a “credit score.” They assign points (positive and negative) to different information (called tradelines in industry jargon) in your file to determine if you’re a good risk.
They look at your mortgages, personal loans, student loans, auto loans, judgments, and credit card debt, payment history, at the total number of credit cards (and credit accounts) you carry, and your level of debt (is it out of whack with your income?). Do you have too many credit inquiries? Do you have a checking and a savings account?
Currently, each creditor uses its own proprietary formula to see if you pass financial muster, but the most common system was created by Fair, Isaac & Co, a San Raphael, California-based data-management services and consulting company. Their credit scoring method is nick-named “FICO,” and it assigns you a credit score between 300 and 900, with most consumers scoring between 500 and 800. Each creditor determines which number will be acceptable.
Since the federal government hasn’t yet seen fit to regulate credit scoring, it’ll be tough for you to know whether or not you’re going to have a problem getting approved for credit until you’ve actually applied.
If you have a lot of negative information on your credit report, and you’re applying for something big, like a home loan, chances are you’re going to have problems. In that case, you’re better off taking six months to fix your credit before you try again.
Whatever you do, don’t keep applying for credit once you’ve been denied without fixing your credit first. You’ll just add more negative information to your credit history.
Personal Finance Tip: Credit laws are constantly changing, often to the consumer’s benefit. A recent change gives consumers a 30-day window to shop for a mortgage. That means you can have a 30-day window for unlimited mortgage-related inquiries without it sounding a warning bell. For all other loans, you now get a 14-day grace period. So if you’re buying a car, you’ll want to shop for your financing within 14 days.
If you get rejected for a loan, it’s hard not to take it personally. Still, buck up and ask the creditor why you’re being rejected. You have up to 60 days to get a free copy of your credit report if you’ve been denied credit.
Under the Equal Credit Opportunity Act (ECOA), the creditor must tell you why you were rejected, though they are not required to tell you the factors and points used in its scoring system.
Use the information to clean up your credit, or improve weak spots. For example, if you’re rejected because you’ve only been at your job a short while, you can wait until you’ve been employed there longer.
Oct. 17, 2003.