That’s what the young man asked me as we began our counseling session. I was a bit surprised at his question, but once he explained, it made sense to me.
He was a recent college graduate, now working a job and a half, but was having problems getting a loan to buy a different car.
“When I went to college I took every credit card I could get, maxed it out, with no intention of paying the debt. My folks were funding my education, so I had little need for credit while I was a college student.”
He continued, “Presently, I am working hard to create a career for myself, but I just found out that these car lenders have access to the record of all that old, unpaid debt, and they won’t give me a car loan because of it.”
“It’s not fair that I am being punished for something I did 5 years ago! I had no idea that someone was keeping track of all that stuff! When did I sign up to have a credit report?”
Here was a perfect time for this young man to learn how the “credit system” works.
First, I explained to him that one does not “sign up” to have a credit report. At age 18, our credit transactions like car loans, credit card payments, bank loans, and student loans are automatically reported to the three credit bureaus. These bureaus compile a record of our credit usage.
“And what is the purpose of that record?” he asked.
“It is for the purpose of credit lenders being able to determine whether we are trustworthy – or more specifically, credit-worthy,” I replied. “They look at our past record and determine our future risk. In other words, our past serves to predict our future. How we used credit before is likely how we will use it again.”
He was still a bit puzzled, so I said, “Suppose your friend Joe approaches you and asks you to loan him $200. You like Joe and want to help him, but you work hard for your money, and you want to be sure he will pay you back.”
“So, you discover a record of how Joe has paid off his debts over the last seven years. You see that there were three or four times when he borrowed money and never repaid it.”
“Would Joe’s past record influence your decision to loan him money today? Sure it would! Not paying his debts in a timely manner before, would make you think loaning him money now is too risky.”
“Or on the other hand, if the report showed Joe paid his debts on time in the past, you would expect him to do so in the future. Right?”
“The car lenders are looking at your past irresponsibility and are afraid to lend you money now. Do you understand why?”
The young man shook his head in agreement. He now realized that it was, indeed “fair” for someone who is going to loan him money to consider his “track record.”
And that, in a nutshell, is the purpose of a credit report. It shows a history of how we have used credit over the last 7-10 years. How much credit, what type of credit, how old the accounts are, and whether or not we pay our debts are all used to calculate our “credit score.”
Our credit report may serve to indict us or endorse us. Either way, it is a fair way for lenders to evaluate the degree of risk we pose as a borrower.
Our next few articles will tell us what to do if our past track record with credit is marred or if there is little history to establish a track record.