Being in the credit reporting industry for over 15 years, I’ve heard that question hundreds of times. “What does a credit score really mean?”
It’s funny because these scores determine whether we approve or are approved for some of the biggest choices in life yet most of us have no idea what the number means or how it’s calculated. Whether the scores are used to evaluate a tenant application, mortgage application or the approval for the purchase of a new car, these scores are powerful. Understanding them is critical to helping you choose the right tenants and for keeping your own credit score as high as possible.
As you already know, there are 3 credit reporting bureaus: Trans Union, Experian and Equifax. For better or worse, that’s it. All of the information that is compiled on a person’s debt, payment and collections history lives at one, two or all three of these bureaus. The data is reported to them from thousands of various creditors, collectors and public record data bases. Not just anyone can report data to the bureaus. Companies and organizations have to be validated as reliable data sources and go through an extensive accreditation process to report data to the bureaus.
That said, that doesn’t mean that all the data reported by the companies reporting to the bureaus is perfectly accurate. Most of it is, but there is an element of human error and technical mess ups in any data reporting. It’s important for everyone to take advantage of the “free credit report” each consumer is allotted annually to ensure the data on your report is accurate.
But even with its occasional errors, the credit report is still the single best tool for evaluating a person’s likelihood to pay as promised. For a property manager or a landlord, I would suggest always pulling a tenant credit report to evaluate an applicant. You’re getting a lengthy snapshot of the renter’s payment history which gives you a good idea of whether they will pay you on time, late or at all.
Let’s look at some quick key information about credit scores and how they are calculated:
What things affect scores, and how much?
The credit score falls in a range of 300-850 with 850 being perfect.
Picture the factors affecting a credit score as a pie chart. The areas affecting the score calculation the most take up the biggest parts of the pie and are therefore weighed more heavily.
This includes the timeliness of payment as reported by accounts including mortgage, credit cards, utilities, auto, etc.
The bureaus are looking at whether accounts are paid as agreed and the severity of any delinquency. They’ll focus on the time since derogatory reporting occurred. But they also evaluate the positive credit following past payment problems. In other words, it’s never too late to start building a better score. They will also weigh the amounts past due on any accounts and the number of items past due. Obviously adverse public records like bankruptcies, liens and judgments carry a lot of weight here.
Amount of credit owing:
This looks at how much money is owed or outstanding.
The amount of money owing on accounts (determined by type of account) is evaluated heavily here along with the number of accounts with balances owing. Another thing that hurts a credit score is carrying a high balance on a revolving credit account even if you have a high credit limit and are paying as agreed. It shows an accumulation of debt with a high risk since it’s not being eliminated month after month.
Length of credit history:
The score is affected by how much credit history has been established. The longer, the better.
This is a tough one for people trying to establish credit for the first time. If they don’t have a lot of time under their belts paying on accounts, it will bring down their scores initially. However, paying the accounts they have on time will build a great score over time. That said, some people open accounts they don’t intend to use just to establish a credit history, or to get that 20% discount at the store (yes, even I’ve done it). But if you never use that account, it actually hurts you. The bureaus look at the dates since last account activity to evaluate the weight and viability of the account and an unused account is seen as a negative. Do you have five store cards open that you seldom or never use? Close them. Best rule of thumb is if you don’t need it, close it or don’t open it in the first place. That 20% discount is not worth the long term hit to your credit score.
New accounts affect the score less since the track record with these accounts is short.
This includes the number of recently opened accounts (which are those store accounts you opened for the discount) the time since account was opened and the number of recent credit inquiries. I’ll say it again, please pass up the store credit cards!
Types of credit in use:
The bureaus like to see a diverse line of credit to illustrate the subject can manage a variety of accounts such as auto, revolving credit cards, bank loans, etc.
Try to maintain a mixture of revolving & installment accounts and pay them as agreed. A good number of accounts is two to five various kinds.
With all the factors considered, it’s important to understand what affects a credit score. It will help you understand what you are looking at when you see your own score or the score of your tenant applicant.
Again, I believe pulling a credit report to screen tenant applicants is a very smart move for landlords and property managers alike, one that can give you insight into the applicant’s payment patterns. It’s better to know upfront than to find out the hard and expensive way. I hope this article was helpful to you. Let us know!