In this edition of The Score, we continue a four-part exploration of the sections of consumer credit reports that have a direct bearing on your credit score, and the relationship between the information they contain and an individual’s credit score. Consumers can (and definitely should) obtain free credit reports once every twelve months at AnnualCreditReport.com.
Credit reports from the three major credit reporting companies—Equifax, Experian, and TransUnion—are each formatted differently. However, the credit reporting companies all group information in similar sections: personal information, accounts activity, public records, and credit inquiries. Although it is crucial to ensure the personal information contained in the reports is accurate, this series does not address that issue because it has no bearing on credit scores. Instead, this series of articles considers the other three sections.
This month is part two of our examination of the account activities section. We began with part one in last month’s newsletter. Articles three and four will look at the impact of public records and credit inquiries, respectively.
In the first part of our series, we explored how credit scoring models consider tradeline or account-activity information, and covered the types of accounts that appear on your credit reports and the negative impact of late payments. In this second article, we stay on the subject of trades, which is industry terminology for a consumer’s credit accounts, but spend more time on the importance of debt, and the age of delinquencies, and how these impact credit scores.
One predictive aspect of a consumer’s trades or accounts is the amount of debt incurred and, more specifically, how much credit card debt a consumer has at any given time. The amount of overall debt reflected in a credit report is “moderately influential” to your VantageScore credit score.
Even more significant to a consumer’s overall credit score is a “highly influential” factor related to credit card debt. This factor is known as the debt-to-limit ratio, or more formally, a consumer’s revolving utilization. Credit scoring models use this as a metric of just how much a consumer has leveraged his or her credit cards. The ratio is calculated by dividing a consumer’s credit card debt by his or her credit limits. And yes, the higher the ratio, the more it will adversely impact your credit scores.
To determine this ratio directly from a credit report, simply divide the sum of all outstanding balances on all credit cards by the sum of all credit limits. Because credit scoring models consider only information in a credit report, it’s important to use the balance and credit limit information as it appears on a credit report and not data obtained from any other sources.
If a consumer has missed payments on his or her credit obligations and those missed payments have been reported to the credit reporting agencies by the lenders, then the credit reports are going to reflect the delinquencies. Credit scoring models will consider those delinquencies, which may lead to a lower credit score. In some scenarios, this will result in a considerably lower score. Scoring models not only factor in the existence of any delinquencies, but also their age, severity (how large the missed payment was, and how late it was paid), and the prevalence of delinquencies in a consumer’s credit history. For example, are the delinquencies rare, isolated events or a recurring pattern?
Credit scoring models will penalize a consumer more if he or she has a large number of missed payments. Credit scoring models will also penalize a consumer more if the delinquencies reflect payments that are many months past due. Finally, scoring models will penalize recent delinquencies more heavily than older ones.
Most scoring systems weigh delinquencies that have occurred in the past 36 months more heavily than those that occurred further in the past. And because delinquencies can only remain on credit reports for up to 7 years, those that are close to their removal dates are much less problematic. Those delinquencies can come back to haunt, however, and are compounded if there are newly missed payments added to the credit report.
Finally, it’s important to point out that the plain-English explanations that appear alongside trade entries in a credit report can also impact a credit score. Lenders that furnish data to the credit reporting companies provide these “narrative codes” to give context to the trade entries. There are dozens of these narrative codes, and most are benignly descriptive, such as “Your Bank Credit Card.” But narrative codes also can flag events that have a negative impact on your credit scores. There are too many to list, but chances are good that if a narrative code sounds negative, such as “Account in bankruptcy,” “Repossession,” or “Account settled for less than full balance,” it’s a pretty good bet the narrative will lower a consumer’s credit score.