Understanding Credit & Debt
How Lenders View Your Credit History
4 Steps to Preparing to Apply for a Loan
When you apply for a large loan, such as a mortgage, automobile loan or small business line of credit, your lender will take a close look at a number of factors, including your credit history. Here are some of the things they consider, and the steps you can take to be better prepared:
Step 1: Know Where You Stand
Check your credit reports on a regular basis, so you know what a potential lender will see. You are entitled to receive a free copy of your credit report once a year from each of the three nationwide consumer credit reporting companies, TransUnion, Equifax and Experian, at https://www.annualcreditreport.com.
Some people like to check the reports on a four-month cycle: If you check one company's report in January, a second one in May and the third in September, by the time it's January again, you'll be eligible to get the next annual free report from the first company. Whatever frequency you choose, being aware and knowledgeable about what's on your credit report is a great place to start.
Step 2: Fix Any Flaws
Mistakes happen, so carefully review your reports from all three companies to make sure there aren't any errors. If there's anything you don't recognize, it could be an indication of identity theft, but there might also be a simpler explanation. "It might be something that's not even yours," says Dennis Maag, a senior lending manager at Chase Mortgage Banking.
If you spot any red flags, follow the dispute procedures given in the report to correct errors. However, if you need to apply for a loan before you have time to resolve any disputes, Maag advises attaching a letter of explanation to the application detailing why the information is wrong.
Step 3: Understand Your Credit Report and Credit Score
Your free credit report will not include a credit score. The report is the raw data from which that score is calculated. You can pay to see your score at each of the three companies while viewing your report online. Some financial institutions offer customers a credit score for free, and some provide additional detail, so customers can better understand what's actually impacting the score.
If you're happy with your score, that's a sign you're building and managing your credit health well. However, if you're unhappy with it, there are steps you can take to improve it. Just remember that progress may take time. For example, allow 60 to 90 days after paying down your overall level of debt to start to see gradual enhancements in your credit score. If you're trying to correct a spotty payment history, lenders often say they like to see a year of timely bill payments. And if you're just beginning to build your credit history, you may need to open more lines of credit and establish a 12-month history of on-time payments, which is one of the biggest factors affecting credit scores.
"Ideally, we like to see three open and active lines of credit for at least the past year," Maag says, and these could include such things as credit cards, car loans or student loans.
Another big factor in your credit score is a concept called "credit utilization." This refers to the ratio of what you owe relative to the amount of credit available to you. Maag says that lenders like to see balances of less than 30 percent of available credit. You don't want to max out the limits on your credit cards, but the smart solution isn't to apply for more cards.
"You don’t want to have too many credit cards, even if your utilization is low,” Maag says. “The fact that you have access to that much credit could pull down your score.”
Step 4: Be Thoughtful About Each Step
Before you take any actions that could impact your credit, consider how they might impact your score and overall credit health. For example, applying to too many lenders can also bring down your credit score. Get turned down for the same loan all over town and that becomes a part of your credit history. "Most people who call us have already been turned down for a loan," says Mike Sullivan, director of education at Take Charge America, a non-profit financial counseling and education agency in Phoenix.
Sullivan recommends doing your research online to find some of the best rates available for real estate and automobile loans, and then going to your financial institution "armed with this knowledge." Although he's not against borrowing from other sources, he says he typically finds that consumers do just as well at their own banks, where an existing customer relationship can often be a positive factor.
Learn how Chase Slate can help you better understand your credit health.
Photo: Peathegee Inc/Getty Images | Shira Boss is a financial writer and author of the nonfiction book “Green with Envy: Why Keeping Up with the Joneses is Keeping Us in Debt.” She has been quoted as a personal finance expert in The New York Times and The Wall Street Journal, and has appeared as an expert on CNN.