Introduction to Understanding Your Credit Report
Your credit report is much more than a seemingly-arbitrary score and a list of the debts and obligations you have had: Your credit report can affect whether you are able to get a loan or credit card, the interest rate you will be charged, whether you can buy a home, and (in some cases) whether you will be hired for a certain position. Despite the credit report’s importance, some Americans do not know how to read their report, how certain decisions will impact their report, and what they can do to improve their report – especially after taking advantage of a debt consolidation or debt settlement offer.
You Are More Than a Number … Aren’t You?
There are three main consumer credit reporting companies (and many other smaller, more specialized companies): Equifax, Transunion, and Experian. When you apply for a new loan, mortgage, or credit line, or apply for certain jobs the loan officer, lender, or potential employer will pull a copy of one or more of your credit reports. Your credit report contains a list of all credit lines, loans, mortgages, student loans, and other installment agreements that you have opened. Your credit report will also include payment history for each of these obligations. For example, the person reviewing your credit report will be able to see whether you have made any payments more than 30 days late and, if so, when this happened (so long as it is within the previous seven years). There is also other information contained in your credit report, such as:
- Whether you filed for bankruptcy within the last seven to ten years and, if so, the disposition of your bankruptcy petition;
- Whether you have had any judgments, tax liens, or collection accounts in the previous seven years;
- Your address and employment history;
- A list of the “inquiries” made into your credit history. A “hard inquiry” occurs anytime you apply for credit or authorize another person to look at your credit report. A record of these hard inquiries is made and each hard inquiry remains on your credit report for one to two years (at least). A “soft inquiry” occurs anytime you pull your own credit report for review or ask another person to pull your credit report so you can review it (websites offering to do this service for you will explicitly advise you whether requesting a copy of your credit report through their company will affect your credit score and/or cause an inquiry to be noted on your credit report). Soft inquiries are not recorded on your credit report and do not affect your credit score.
Lastly, if you are applying for credit your credit report will contain a “credit score” for the individual who is requesting your report. The score is typically a three-digit number ranging anywhere from about 300 to about 850 (or some other similar range): this number represents your creditworthiness. The higher the number, the greater your creditworthiness and the more likely it is that you will receive the job, loan, or credit line you requested. There are a number of formulas used to calculate your credit score, and each lender may employ one or more formulas depending on the reason for the credit (i.e., a mortgage application may use a different formula than a credit card application). However, most every formula used for calculating your credit score will take into account five factors: (1) your payment history; (2) the amount of debt you have in relation to your available credit; (3) the average age of your credit accounts; (4) the number of inquiries you have had within the previous one to two years; and (5) the “mix” of credit accounts you have, i.e., whether you have multiple types of loans and obligations or whether you only have one type of credit obligation. Each lender will have specific guidelines as to the credit score it deems “acceptable” for the type of credit you are seeking.
Negative Items on Your Credit Reports
When you fall behind in your payments, have a judgment entered against you, file for bankruptcy, or have an account go into collections, this information is reported to one or more of the credit bureaus. Each item will remain on your credit report for seven to ten years from the date it was first reported. For example, a Chapter 7 bankruptcy will remain on your credit report for ten years from the date your petition was filed: A debtor who filed for Chapter 7 in 2016 will have that notation removed from his or her credit report in 2026. Suppose you had a credit card that you stopped paying in 2014 and it went into collections in 2016: Here, the derogatory information will be removed from your credit report in 2021, seven years after your account first became delinquent.
The more time that has elapsed since negative information was first reported, the less effect it will have on your credit score and a credit-based decision. For example, a 90-day late payment will have a significant effect on your credit score for the initial two to three years. However, as time goes on and you reestablish a good payment history, the 90-day late payment will have less and less of an effect on credit decisions.
How Debt Settlements and Debt Consolidation Plans Handled on Credit Reports
Many people enter debt consolidation or debt settlement plans as a means of protecting what little creditworthiness they may have after missing several payments. Debt consolidation plans and debt settlement plans are treated differently on your credit report, so it is important to understand the difference between these two debt relief options. In debt consolidation, you employ a company on your behalf to act as a central payor for all of your creditors. This company negotiates a monthly payment with each of your creditors. You are responsible for paying a lump sum to cover each of these monthly payments to the company each month. The company then distributes the agreed-upon monthly payment to each of your creditors. In a debt consolidation plan, you generally pay all of the outstanding debt you owe.
Debt settlement operates slightly differently. In a debt settlement play, you (or a company on your behalf) collect money until you have accumulated a sufficient sum of money to make a creditor to whom you owe money a reasonable settlement offer. You essentially offer to pay the creditor a fraction of what you owe in a lump sum payment in return for forgiveness of the remainder of your obligation. For example, debt settlement would occur if you owed a credit card company $3,000 but offered to settle the debt for a $1,000 lump sum payment. If accepted, the credit card company would write off the remaining $2,000 you would otherwise owe.
There are important points to keep in mind about how these two different debt relief plans will be reported on your credit report:
- Any late payments you incurred prior to the implementation of a debt settlement or debt consolidation plan will remain on your credit report as a negative item;
- In a debt consolidation plan, the creditor may close your account as a condition of agreeing to the plan. The closure of a credit account by the creditor is a negative item that will be reported on your credit report. So long as you pay the agreed-upon lump sum each month, however, no further negative information should be reported on your credit report as it pertains to that account.
- In a debt settlement plan, negative payment history will continue to accumulate until your account is either brought current or until you make a settlement offer and that offer is accepted and executed. Once it is executed, your account will be closed (if it has not been closed already) and a notation of “charge-off” will be made in your credit report. This informs future lenders that you did not pay back the full amount that you owed on this particular obligation.
As noted above, negative information will remain on your credit report for seven to ten years but will lose its potency over time (so long that you have reestablished a good payment history and carry out your debt settlement plan or debt consolidation plan as agreed). When you choose to resolve your debts through a debt settlement plan, it is better to attempt to settle your debts as close together as possible as opposed to settling one debt one year and another debt the next. To illustrate, consider a debtor who is seeking to settle seven delinquent debts. He may choose one of the two following alternatives:
- If he chooses to settle all seven debts in one year, his credit score is likely to suffer serious damage. However, at the conclusion of seven years the effect these debt settlement agreements will have on his or her credit is miniscule since he will have six years of good payment history established.
- If he chooses to settle one debt a year for seven years, his credit will be in much worse shape at the end of seven years. At the end of seven years, he will still have a charge-off due to a debt settlement on his credit report that is less than a year old, and this will have a significant impact on his credit score.
Finally, note that in debt consolidation or debt settlement you may have some ability to control what, if anything, gets reported to the credit reporting bureaus. You may make a consolidation or settlement offer and include a provision that states, if approved, the creditor must cease reporting any prior late payments and may not include any negative information such as “charge-off” on your credit report. Of course a creditor may refuse to such terms, but it is always worth trying to better your credit in whatever way possible after debt consolidation or debt settlement. For more information about understanding your credit report contact the experienced debt settlement attorneys at Ariano & Associates, PLLC.
Experian, Equifax, and Transunion are three of the main credit reporting bureaus that maintain a “credit report” on you. This credit report has a record of your active accounts for the previous ten years and maintains information concerning your payment history, collections, bankruptcies, and judgments entered against you (amongst other information). When a lender or potential employer makes a “hard” inquiry and pulls your credit report, that lender or potential employer is also going to see a “credit score” – a three-digit number that relates to your creditworthiness. Debt consolidation and debt settlement will both affect this credit score in different ways, and deciding whether to pursue debt settlement or debt consolidation is a decision that should be made after careful consideration of these differences. Nonetheless, any negative information reported as part of a debt settlement or debt consolidation agreement will gradually have less and less of an effect on your credit score as time goes on.