Chapter 3d: Credit & Credit Building

In today's economy, a consumer's credit score is used to determine interest rates for car loans or mortgages, opportunities for rental housing, employment, and utilities. A credit score is a number that reflects ‘creditworthiness’ or how likely a consumer is to pay back a loan. A credit report is a record of a consumer’s previous financial experiences — what accounts are open, how much debt is outstanding, and whether bills were paid on time. This financial history is reported to one, two, or all three credit bureaus (Equifax, Experian, and TransUnion). These tools, the credit report and score, are most commonly used to determine if a consumer will receive a loan or credit card and at what interest rate. A higher score saves hundreds of thousands of dollars – check out this calculator on myFICO.com to calculate different savings amounts based on current rates.

Many low-income consumers who struggle with poor credit or no credit use cash to purchase products and rely on payday lenders, check cashers, and other alternative financial services for borrowing needs. These vendors typically don’t report consumers’ repayment activity to the credit bureaus. Credit reporting is expensive, time consuming, and optional. It is a vicious cycle for consumers with poor credit: they are cut out of the system because they have a low score, and they are not able to build a score because they can't access credit from lenders who will report to the bureaus. This problem is widespread — Center for Financial Services Innovation (CFSI) estimates about 70 million people have no credit files or very thin files and are ‘unscoreable.’

CREDIT REPORT VS CREDIT SCORE

A credit report is a record of any and all lines of credit that have been extended to an individual. For example: credit cards, mortgages, unpaid medical bills that went to collections, car loan, student loan. Every consumer has the right per the Fair Credit Reporting Act (FCRA) to pull her own credit report for free once a year at annualcreditreport.com. This education report does not come with a credit score. The credit score is an additional product that has to be purchased separately and several companies have created thousands of different credit scores. Credit scores are based on proprietary algorithms and are sold separately. The most popular and widely used credit score is the FICO which was created by the Fair Isaac Corporation, a company that helps analyze the credit risk of consumers.

In more simple terms (thanks to Capital Good Fund’s intern guide): “Your credit report is the raw data, while your credit score is what a lender makes of that data using one of dozens of credit scoring models. Lin likened this to preparing a meal. The credit report is your raw ingredients, the scoring model is your recipe, and the three digit number you get out as a credit score is the finished dish.”

Credit reports are only available to parties that have a permissible purpose, a legal reason, to view a consumer’s credit reports. For example, evaluating an application for a loan is a permissible purpose that allows a lender to pull a consumer's credit report. There are several purposes besides credit transactions including employment purposes, insurance underwriting, government financial responsibility laws, court orders, subpoenas, written permission from the consumer, legitimate business needs, and others. If you’re interested to read details, you can review permissible purposes outlined in the Fair Credit Reporting Act, navigate to page 12 or Section 604 of the FCRA here.

It is also worth mentioning that credit reports come in many different formats depending on which company is selling them and whether it is a business or consumer report. When a business receives a report directly from a credit bureau or data reseller, the report is a B2B (Business to business). This report contains the same information as the report a consumer receives when they request their annual free report online, a B2C (business to consumer) report.

WHAT SHOWS UP ON A CREDIT REPORT?
On every credit report, personal information (name, address, social security number - if consumer has one, date of birth, and sometimes employment information) will show up. Opened and closed (within the last 7 years, 10 years for bankruptcies) accounts such as mortgages, credit cards, installment loans will show date account was opened, credit limit or loan amount, account balance and payment history. Credit reporting agencies collect information from state and county courts and civil judgments, bankruptcies, foreclosures, lawsuits, and liens will show up on credit reports. More details are online at myfico.com on what shows up on credit reports.

WHAT'S IN A FICO CREDIT SCORE?
Check out this graph from myfico.com that shows the breakdown of what goes into a person's score. Read more online here.
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WHY SHOULD WE PULL A CLIENT'S CREDIT REPORT?

Credit reports show a consumers’ previous experience with credit and reveal what other debt obligations the client has. Many of Lend for America's members’ clients have little or no credit, however, it is still important to pull the credit report in order to have full information about your client’s credit history and to create a plan to build credit. Additionally, it is important to start with full information about a client’s credit history – many consumers are not fully aware of what is being reported on them and sometimes consumers will uncover erroneous information on their report that should be removed.

The credit report should be built into your decision making process for extending credit to an individual. If your client has civil judgments, major credit card debt obligations, or owes several months of back pay on a mortgage, then you should probably deny the application and consider extending a credit builder loan or other financial coaching plan. Keep in mind, there are other indicators of an individual’s creditworthiness that do not show up on a credit report that should be considered in addition to the credit report. For example, a landlord reference check to determine whether your client 's rent payments have been on time and a review of their utility bills for on time payments and high balances.

HOW DO WE HELP CONSUMERS BUILD CREDIT?

As you are developing your products and services, consider how to incorporate credit building into them. Each client meeting, consultation session, training class, or late payment collections call is an opportunity to touch base about your client’s credit building plan. Each consumer has a unique credit file and there is no silver bullet strategy for credit building. The first step is to pull and review an individual’s credit report and then create a custom credit building plan. Below are some strategies and guidelines for building credit:

New, active, positive credit: Many consumers are ‘unscoreable’ meaning when you pull a credit report, the consumer does not have enough tradelines (accounts: loans, mortgages, credit cards, other debts) and there is not sufficient data for the credit bureaus to calculate a score. One of the best ways to build credit, especially if a person’s file is too thin, is to open a new line of credit and start creating positive repayment history. A new account that is paid back each month on time starts to demonstrate a person’s positive financial performance and can build a credit score in 3 to 6 months. We have found that for someone that has no credit, a credit builder loan will build them a score of 660 within 6 months (as it's a controlled experiment, we've seen the same result multiple times). For someone with limited credit history but no credit score, it really depends — they will probably land somewhere between 600-660. We have found the size of the account does not matter – a $150 loan and a $10,000 loan will provide the same credit score boost.

On time payments: We know, for sure, late payments damage a credit score. We also know, conversely, that on-time payments can improve a score. Make at least the minimum payment, on time, every month.

Pay off debt: A person with lots of debt needs a ‘getting out of debt’ strategy to complement other behaviors above.

Dispute errors: Often, when you walk through the credit report with your client, you may discover errors. Per the FCRA, a consumer reporting agency must correct or delete information that is found to be inaccurate or can no longer be verified. For example, a collections account shows up that your client already paid and she can prove it. These errors can be fixed by disputing the mistakes directly with collections agency, creditor, or with the credit bureaus (Experian, Equifax, and TransUnion). Be sure to dispute errors with all 3 bureaus. It is important to follow up after the dispute to be sure the mistake came off the report. For more information, see How to Dispute Errors in Your Report.

Negotiation tips for collections agencies and creditors: Another strategy is to tackle collections agencies by offering an amount of money that is not the full balance owed to the agency. Check out this tip sheet from Credit Builders Alliance to learn strategies for negotiating with collections agencies.