The backbone of the consumer finance industry is knowing how likely a person is to pay back their debt when credit is extended to them. This started hundreds of years ago through the concept that a city’s merchants would get together and talk about their customers – who paid on time, who was slow to pay, but eventually paid in full, and who failed to pay in full. If you wanted to be part of the circle of merchants and get information about customers and potential customers you needed to share your experience with the customer with the group as well. As cities grew and people moved around more, there needed to be a better way to handle this part of business, and the idea of formal credit reporting evolved.
There are three major credit bureaus in the United States: Equifax, Experian, and Trans Union. There are others, but they don’t meet the generally regarded definition of “major”. Almost every person that has ever applied for any type of credit is on the file of at least one, and usually all three of the major credit bureaus. And the business works similar enough to the initial circle of merchants – if a bank (or other type of lender) wants to subscribe to receive credit reports about applicants they also need to share information with the credit bureau about the performance of the customers that have outstanding loans with them – does the customer pay on time, and in sufficient amount, and how much credit did the lender extend and what is the current amount outstanding, among other things.
Thus, an individual’s credit report contains information about the performance in paying back credit in the past, shows which accounts are closed and why, and which accounts are open and how much credit the individual has outstanding on those open accounts. It shows month by month for each account if sufficient payment was made, and if not, how far behind the individual got – in 30 day increments (months). The type of account is also noted, so creditors can see if it is a mortgage or auto loan or other installment loan, or if it’s revolving credit, like a credit card, where the past performance is important to know, but it’s also important to know how much more the customer could draw and how much bigger the payments could get if the customer uses more of their credit.
The credit report itself is simply all of this information about the consumer’s performance with previous credit products, as reported by the creditors each month. The credit score isn’t technically part of the credit report, but instead a credit score is the result of a complex formula based on many factors that have generally been shown to predict risk – the risk to the lender that the consumer won’t pay back the credit extended. There are several scoring models, put together by a few different companies, and the two most famous you’ll hear about are the FICO score, developed and managed by a company called Fair Issac Company, and the Vantage score, developed and managed by a joint group of the three major credit bureaus.
We’ll go into further detail on credit reporting, credit scores, and some of the publicly available items that are known about how scores are calculated in some articles that are coming soon.