Credit Reports and Scores are more important than ever!
In July, the Federal Reserve raised interest rates one more time to reach a 20 year high. Higher rates have meant savers are finally seeing their cash grow. Higher rates also mean that borrowing costs are the highest they have been in decades. Your credit score, which is driven by the data in your credit report, plays the largest role in determining the interest rate that lenders will offer you.
Consider this, auto loans for a new car through USAA start at 5.54% and 8.89% for a used car. When starting rates are over 5%, your credit report matters more than ever. Nothing illustrates this more than the cost of a Toyota Tacoma in 2003 vs 2023. In 2003, you would have been paying 5.54% on a $12,610 loan. In 2023, you would pay 5.54% on a $30,415 loan for a new Toyota Tacoma, if you have the best credit report and score. Deliberately building your credit history saves you money and opens many more opportunities.
Credit Reports vs Credit Scores
One misconception that I see a lot is an outsized emphasis on credit scores without understanding the underlying credit report. This makes sense as credit scores get all the media attention. Credit scores are a quick summary of the complex financial data that is your financial life. Your credit report is a detailed compilation of your financial history. Lenders use that data to evaluate the risk of issuing a loan to a borrower. Lenders assess that risk by assessing the three Cs of credit reports: Character, Capacity, and Collateral. That assessment translates into your credit score. Build and manage your financial history and raising or maintaining your score will naturally follow.
High-Interest Rates
When rates rise, borrowing costs increase. You don’t need me to tell you about what you experience directly as a consumer. Rising rates also drive an increased risk of default. That rising default risk affects how lenders assess the three Cs. Default risk skews toward borrowers whose underlying financial data, captured in the credit report, reflect challenges to character, capacity, and capital. Those borrowers, whose increased risk of default is represented by a lower credit score, are the first to face the highest borrowing cost. They are also the first to lose access (get denied) to new credit as lending tightens.
For borrowers with higher credit scores, those with positive character, capacity, and capital reflected in their credit report, also experience increased borrowing costs. However, lenders reserve the best rates for borrowers with more positive credit reports (and therefore higher credit scores). Borrowers with the best credit reports and scores typically maintain access to credit, even when lending tightens.
Building and managing your credit history is always important. Rising interest rates and tightening credit markets amplify the impact of negative credit reports on borrowers.
Build a Better Credit Report- Your Score Will Follow
When it comes to building or rebuilding your credit report there are no quick fixes. This is because your credit report is your history of managing your financial life. Don’t get scammed by a pop-up ad promising to fix your credit history for a one-time payment. You already have the power to fix incorrect information, add statements to your file, and take steps to build positive history.
Start by checking your credit report
You can access your credit report for free at www.annualcreditreport.com. During the pandemic consumers were allowed to access free credit reports through Transunion, Experian, and Equifax weekly. This was a big change from the free credit report offered annually in the past. Annualcreditreport.com continues to offer free credit reports weekly. So, check your credit report. Check your report even if you have good credit.
Review your credit report for inaccurate information
Read through all the pages of your credit report and make note of any inaccurate information, including things that you don’t remember. Use the dispute process offered by the credit reporting agency that manages the report to dispute incorrect information. These may be things like addresses you never lived at, phone numbers that aren’t yours, birthdates that are incorrect, aliases that aren’t yours, or credit items that you did not open. Review the inquiries on your credit report. If you have a lot of soft inquiries, or credit inquiries that were initiated by companies wanting to offer you credit, put yourself on the opt out list. Visit OptOutPrescreen.com and put yourself on the list to opt out of these offers.
This is especially important for active duty military who move frequently. Imagine all those pre-screened offers for credit cards being sent to your old address and whoever lives there now.
Review negative information
Your payment history is one way lenders assess your character, by reviewing your history of making payments on time. Reviewing your credit report can be emotionally difficult. Missed payments and defaults usually coincide with difficult times in peoples’ lives—a deployment, a really bad PCS, a spouse’s lost job, a divorce, a loss in the family. Reviewing your credit report can be a painful reminder of those times. If you have negative information on your credit report, look for a professional who understands credit and your situation as a military family. Accredited Financial Counselors (AFC®) and some Certified Financial Planner™ Professionals (CFP®) offer these services. Depending on your location, you may have access to a Personal Financial Counselor assigned to your base. If not, Military OneSource may be able to connect you to someone in your area or online.
Negative and accurate information can remain on your credit report for up to 7 years. Agencies treat negative medical payment information differently from other types of collections. If you find negative inaccurate information, file a dispute. If you find outdated information, negative payment history that is more than 7 years old, file a dispute and request removal.
Mind your capacity
Your capacity reflects your ability to repay a loan. When you are reviewing your credit report, consider the total amount of debt that you have relative to your income. This is often referred to as your debt-to-income ratio. Look at each of your credit items to ensure that the details are correct. If you have a high debt to income ratio, paying down debt will result in an improved credit score. As your debt is paid down, your capacity to repay remaining debts increases.
Track your collateral
Having assets that can be used to repay a loan if you are no longer able to make monthly payments decreases the risk to the lender. Collateral can be short term savings, long term investments, equity in real estate, the market value of car or other items of value that you borrow against. While you may not use your savings to secure a loan, having cash savings in combination with a good payment history and a low debt to income ration can help you get the best rates when borrowing.
Military service members know that credit reports are used for more than just lending. Credit reports are used for security clearance reviews, by landlords, by insurance companies, and even by mobile phone carriers. Lenders routinely review credit reports on existing revolving credit to determine rates and eligibility. As interest rates rise, building and maintaining your credit report will be important, even if you do not intend to apply for a new loan. Credit reports will continue to shape what you pay for cell phones and insurance. A positive credit report may be the key for future employment.
Additional Resources
Consumer Finance tool for military
Service Member’s Civil Relief Act
Do you need help understanding your credit report or building a solid financial plan? The MFAA advisors can help. Consider setting up a call with one today. You can see all our advisors here.