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How the Credit System Works

illustration depicting a formal discussion about credit

What is Credit History?

Your credit history is a record of how you’ve handled the repayment of your debt. It is essentially the history you’ve established with the 3 major credit bureaus by either paying or not paying your bills on time, or not paying at all. Make no mistake about it, your credit history is one of the most important components of your financial life.

The 3 major credit bureaus are Equifax, TransUnion and Experian. Some people might be under the impression that these credit bureaus are non-profit organizations that always act in the best interest of consumers. Nothing could be further from the truth. Credit bureaus are privately held, billion dollar companies who exist solely for the purpose of making money. They store data that lenders furnish them – whether accurate or inaccurate – about our credit relationship with them and then sell the information in your report to creditors, insurers, employers, and other businesses that use it to evaluate your applications for credit, insurance, employment, or renting a home. This simple business model generates over $4 Billion a year!

The major source of income for these credit bureaus comes from selling the information on our credit reports to other lenders, employers, insurance companies, credit card companies – and whoever else you have authorized to view your credit information. They use this information to evaluate your applications for credit, insurance, employment, or a lease.

Not only do they provide them with raw data; but they also sell them different ways of analyzing the data to determine the risk of extending credit to us. In addition to selling our information to lenders they also sell our information to us – credit scores, credit monitoring services, fraud protection, identity theft prevention, and more.

The bureaus have a legal responsibility to comply with the Fair Credit Reporting Act, and follow the law that protects the consumer.

What is a Credit Report?

A credit report is a record of your credit history compiled by the credit bureaus from a number of sources, including banks, insurance agencies, retailers, credit card companies, collections agencies and governments. It is chock full of information on where you live, how you pay your bills, and whether you’ve been sued, arrested, or filed for bankruptcy.

These reports will reflect your payment history on all of your credit accounts you’ve had in the past. This includes your credit cards, student loans, mortgages, retail store credit cards, auto loans, telephone, and utilities.

Having a good credit report means it will be easier for you to get loans and lower interest rates. Lower interest rates usually translate into smaller monthly payments. The credit bureaus are allowed to have negative items on the credit report only if it is 100% accurate and also verifiable.

It is significant to note that these credit bureaus don’t share information with each other. They also never bother verifying whether the information that have on you is accurate or up-to-date so your credit reports can contain major discrepancies that could be potentially damaging to your credit history. Thus the onus of verifying that the information contained in your credit report is 100% accurate falls on you.

You are solely responsible for ensuring that the information contained in each of the credit reports is completely error free, because you can never be sure which one will be used whenever you apply for a new account.

Note that credit bureaus have no direct influence on whether you should be approved for a loan or not; that depends on the credit criteria of the lender requesting the information. However, by evaluating all of the information contained in your credit report (payment history, personal information, and credit habits) and FICO’s method of scoring that data, they do provide meaningful insights into your creditworthiness. This is why it’s so important to ensure that the information they are reporting is accurate.

How the Credit Bureaus Compile Your Information

The entire credit reporting system consists of three main players: you (the consumer), the credit bureaus and creditors (the companies who grant you credit). There are two major sources that the credit bureaus use to gather your credit information.


Subscribers are creditors, and are also known as information providers. These include auto lenders, insurance agencies, banks, credit card companies, retailers, jewellery stores, etc. Your creditors electronically send information about your credit behavior to the three national credit bureaus every 30 days.

This information is stored and compiled into reports by the credit bureaus, and is used to calculate your credit score. It is then sold back to these creditors when they are looking for potential clients for credit cards, loans and other types of finance related offers. The more information these credit bureaus can collect on each individual, the better off they’re going to be.

Public Records

Public records are freely accessible by anyone. These records include judgments, bankruptcies, tax liens, divorce settlements, satisfied judgments, satisfied liens, wage attachments and notices of default properties. In other words, if your landlord takes you to court for non-payment of rent, the credit bureaus are going to know about it.

The problem with public records is that the agencies in charge of keeping track of them are all too happy to let the credit bureaus know when you have fallen behind on your payments, but they’re never in a hurry when it comes to updating the records to let them know that the account is in good standing.

These negative records have a severe impact on your credit report, so if you’ve had a court ruling that’s impacting your credit report it’s vitally important to make sure it’s removed if and when it has been satisfied.

The information contained in your credit report tends to include:

  • Your name
  • Address
  • Employer
  • Credit card records
  • Loan account records
  • Bankruptcies
  • Tax liens
  • Judgements

Whenever you submit a credit application, the information in your credit report is used by businesses to determine your credit-worthiness. The lower the risk that you pose as a customer, the better the rates you’ll have to pay for credit.

Industry experts suggest that you review your credit report on a periodic basis for the following reasons:

  • The information it contains affects whether you can the loan you have applied for, and how much it will cost you to borrow the money.
  • To make sure the information is accurate, complete, and up-to-date before you apply for a loan for a major purchase such as a house or car, buy insurance, or apply for a job.
  • To help guard against identity theft. This occurs when someone uses your personal information to take out a loan or open a new credit card account in your name. Then, when they don’t pay the bills, the delinquent account is reported on your credit report. This could affect your ability to get credit, insurance, or even a job.

Obtaining Your Credit Reports

As mentioned earlier, the information contained in your credit reports will impact the type of deals and interest you are offered when you finance a purchase. Prospective employers will also look at this information before hiring you. It is therefore important to know what lenders see when they review your credit.

Don’t be afraid to check out the information on your credit reports. It’s important to know exactly where you stand today and be in a position to improve it, rather not knowing at all. If you are concerned about lowering your score if you check your own credit report, you have nothing to worry about. Checking your own credit is known as a soft inquiry and will not impact your score in any way. In fact, you can check your credit report 10 times a day if you want; it won’t impact your score at all.

By law, you are entitled to a free copy of your credit report every year from each of the three major credit reporting companies. You can download them at www.annualcreditreport.com. Note that most information expires from your credit reports after 7-10 years.

You’re also entitled to a free report if a company denies your application for credit, insurance, or employment, based on information in your report. You must ask for your report within 60 days of receiving notice of the action. The notice will give you the name, address, and phone number of the credit reporting company.

There is almost always erroneous, inaccurate and outdated information contained in the credit reports. Cleaning up your credit report is pretty much straight-forward: you have to dispute each of the erroneous, unverifiable or incorrect entries then file a dispute to compel the credit bureaus to delete such items from your report.

Monitoring Your Credit

One way of keeping abreast of every piece of information that is included in your credit report is by availing yourself of a credit monitoring service that keeps track of information from all three credit reporting bureaus and will alert you to incorrect information that has been included in any of your reports.

For example, if someone has fraudulently opened a credit account in your name, you’ll be the first to know about it. Essentially, this will allow you to take the required steps to protect your credit report from being damaged by false information. Alternatively, you can pull at least one credit report every 3 months. Check out the data and if you find errors, dispute them right away.

Furthermore, be sure to opt out of those lists sold to other companies to prevent them from selling your information. Finally, you can also check your credit score for free each month using credit.com’s free Credit Report Card.