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How does credit work?

Wednesday, March 08, 2017
In July 2016, the Consumer Federation of America (CFA) and VantageScore Solutions reported that most consumers (more than 80%) knew basic facts about their credit scores, including that they’re used by lenders for mortgages and by credit card issuers. While it’s good that most people know the importance of these scores, the same survey found, however, that many consumers don’t understand credit score details. In other words, confusion persists about how credit works.

How Does Credit Reporting Work?

When you borrow money, whether through a revolving account (like credit cards) or an installment account (like an auto loan or student loan), this information is gathered by credit bureaus (more on that later). The data the bureaus have in your credit files is used to calculate your credit scores. Your credit scores are determined by five major factors:
  • payment history
  • your debt usage
  • age of credit accounts
  • types of accounts
  • the number of inquiries on your credit.
These scores are then used to determine your risk factor for future loans. The three-digit score is a numerical representation that indicates how risky a borrower you are from a lender’s perspective. A higher credit score can help improve the terms and conditions you qualify for. For example, your credit reports and/or scores impact the deals and interest you will receive when you buy a home, finance a car, rent an apartment, apply for a job, buy insurance, purchase a cell phone, or open a new credit card.

The best way to have healthy credit is to remain responsible about the credit cards or loans you have. Remember those five factors we mentioned a minute ago? This is where they come into play — things like making your loan payments on time each month and maintaining a good credit utilization ratio (the amount of debt you have in relation to your overall credit limit) can help you get those good sought-after scores. Using credit irresponsibly by making late payments and maxing out credit limits can have damaging effects on your credit.

How Does Credit Reporting Work?

The credit reporting system is made up of three main players:
  • consumers
  • credit bureaus
  • financial companies
Information about your credit cards, loan accounts and credit inquiries is reported electronically to the three main national credit bureaus — TransUnion, Equifax and Experian — by lenders and creditors about every 30 days. These bureaus collect and store your credit information in your credit profile for future reference. Meaning, your behaviors can be reviewed in the future by others to determine your risk level.

Businesses such as auto loan lenders, banks, credit card companies and insurance agencies use your credit data from the credit bureaus to determine your risk level. Once they have an idea of how risky it is to lend you money, they can determine the rates you’ll have to pay or other terms and conditions. They may also use this information to send you pre-approved offers in the mail.

The three national credit bureaus don’t share information with each other and not all lenders or creditors report to each. Because of this, your credit reports from TransUnion, Equifax and Experian can contain significantly different information about you. So, it’s important to monitor all three reports because you can never be sure which one will be used when you apply for a new account. You also want to make sure you review them for any errors that are damaging your scores. You can read this guide to learn more about how to dispute an error on your credit reports.

Are Creditors Required to Report to Credit Bureaus?

Not all creditors will report your account information to the credit bureaus, as they are not required to do so. While businesses are legally required to report accurate information, there is no law that says they have to report at all. While nearly every major creditor reports to all three bureaus, smaller lenders and banks may not send your monthly account information to all three or any of the credit bureaus.

What Appears on Your Credit Reports?

Along with your credit card and loan account records, basic information about you — like your name, address and recent applications — are recorded in your credit files. Public records such as bankruptcies, tax liens, and judgments can also appear on your reports. Information about your income, race, gender, age, religion or health details is not included on credit reports. Most information expires from your credit reports after 7-10 years, but this can vary depending on the circumstance. It’s important to keep the information on your credit reports positive and accurate. As we mentioned earlier, if there is something inaccurate on your credit reports, you can file a dispute to have it removed from your record.

Find Out Where You Stand

Finding out how credit works is important — and now that you’ve done that, you likely want to know where yours stands. You can see a free snapshot of your credit report, updated every 14 days, on When you do so, you’ll also see a free break down of your credit scores, including a grade for each section that makes up your scores. You’ll see, for example, how your payment history, debt and other factors affect your scores, and you’ll get recommendations for steps you may want to consider to address any problems or how to continue down the right path. Something else that’s important to remember about how credit works is that viewing your own credit reports and scores will not affect your credit in any way.



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Disclaimer: Improvement of your credit score and/or particular results vary per client. We cannot guarantee any results or improvement as stated in our Guarantee Disclaimer. Following our best results practices and educational consulting, we do typically see improvement in credit scores.