Were you, a friend or family member denied credit? It happens just about every day. The Dodd-Frank Act requires financial institutions to send their applicants letters explaining why they were denied a loan or some other form of credit. These letters are also to include the consumer’s credit score, a two-digit code and a brief explanation as to what that code means.
But many people still don’t understand why they were rejected.
To help consumers
The reason why this requirement was included in the Dodd-Frank act was to help consumers understand not just why they were denied credit but also to help them improve it. However, a recent survey of 200 lenders found that 75% said they worry that their customers don’t understand the disclosure letters and only a tiny 10% felt that their customers “understand reason codes well.”
55 reason codes
There are 55, yes 55, different “reason codes” or reasons why consumers are denied credit. Some of them practically defy understanding. For example, here are five explanations that probably confuse a lot more than they enlighten.
- Proportion of loan balances to loan amounts is too high
- No recent revolving balances
- Length of time since derogatory public record or collection is too short
- Date of last inquiry too recent
- Number of bank or national revolving accounts with balances
The problem with these reason codes is that they were written by the people who develop credit scores and tend to have confusing terminology or are too short to provide helpful information. As another example of this, the explanation of reason code 39 is” Serious delinquency.” If this were put into simpler terms it would explain that the consumer had an account where a payment was at least 30 days late.
Here’s yet another example. Reason code 8 states, “You have too many inquiries on your credit report.” If you don’t know what an inquiry is or how it happens, this can be very confusing. The reality is that an inquiry occurs whenever a lender runs a credit check on you. This means that whenever you apply for an auto loan, a credit card or some other form of credit, an “inquiry” is generated, which can reduce your score by 10 to 20 points.
A second reason why people are having a tough time understanding the explanations is due to the fact that only about 10% of the lenders translate their disclosures into Spanish. This means many Spanish-speaking applicants can’t read the explanations at all.
Frustration among consumers
About 50% of the lenders who were surveyed said there is frustration among consumers because of a lack of clear communication. Nearly 30% said it would be helpful if applicants were given tips for improving their credit scores and 33% reported that it would help a great deal if the explanations were written in clear and easier to understand language.
How to get a better explanation
In response to this information, the company VantageScore recently launched a website titled ReasonCode.org to help consumers better understand why they were denied credit. If you were denied credit and are not sure why, you can go to this site, type in the reason code that you were given and get an explanation of the code that should be easier to understand. Plus, you will be provided with information as to how you could improve your credit. The company has also translated its website into Spanish and created an easy-to-understand video with good information about how reason codes work.
The five components of your credit score
As nearly as I can tell the 55 codes used to explain why you were denied credit are just subsets of the five components that are used to create a credit score, which are:
- Payment History – 25%
- Credit Utilization – 30%
- Length of credit history – 15%
- Types of credit used – 10%
- Recent searches for credit – 10%
What these mean
Payment history is pretty self-explanatory. It’s simply how you’ve used credit – as in did you pay your bills on time. If you have accounts that have gone to collection, late payments, defaults or missed payments these will be reflected in your payment history and your credit score will be reduced accordingly.
Credit utilization is a bit more complicated. It’s the amount of credit you’ve used vs. the total amount of credit you have available. As an example of this, if you have credit cards with a total credit limit of $5000 and have charged $1000, you would have a debt-to-credit ratio of 20%, which would be considered good. On the other hand if you had charged up $2000 on those cards your debt-to-credit ratio would be 40% and this would have a negative effect on your credit score.
Credit history is also simple. It’s just the length of time that you’ve had credit. If you opened your first credit card when you were 21 and are now 40 you would have a 19-your credit history and this should have a positive effect on your credit score.
Types of credit used is just that – the different types of credit you’ve used. For example, if you’ve had an auto loan, several credit cards, a personal line of credit and a mortgage loan, this is good because it shows potential lenders that you have successfully managed various types of credit.
Finally, there is the recent searches for credit. This is the “inquiries” that are part of reason code 85 as explained in a previous paragraph. While this accounts for only 10% of your credit score it still pays to be careful and not make too many applications for credit within the same year. When lenders see this it makes it look as if you had been in some desperate financial condition.
How to bump up your credit score
First, if you don’t know your credit score you need to get it. It’s available free once a year from the three credit reporting bureaus – Experian, TransUnion and Equifax – or the site www.annualcreditreport.com. If you find that you have a low FICO score of 580 or less, there is one thing you could do to give it a quick boost. Calculate your credit usage (your debt-to-credit ratio). If you find it’s higher than 30%, pay down some of your debt. If this isn’t possible, you might be able to talk one of your lenders into increasing your credit limit, which would have the same effect as if you paid down one of your debts.
Review your credit report
If you’re denied credit because of something in your credit report you’re entitled to a free copy so you could make sure the information in it is accurate.
It’s important to get and carefully review your credit report. It’s possible that it contains errors. For example, a debt that went to collection could be that of someone with a similar name. Or maybe a financial institution incorrectly reported that you were late in making a payment.
If you do find an error such as this, you need to dispute it by writing a letter to the credit bureau with any documentation you have supporting your claim. When the credit bureau receives your letter, it must contact the company that provided the information and ask that it be verified. In the event that it cannot verify the information or fails to respond within 30 days, the credit bureau must remove the item from your credit file. This, too, could give your credit score a nice bump.
In the event you do have negative items in your credit report, you need to get to work to repair it. For example, if your report shows that you’ve missed payments in the past you need to get and stay current on all your bills. Your FICO score will go up the longer you pay all your bills on time. And here’s the best news. If you’ve had credit problems in the past, they will fade away over time – assuming you continue to make all your payments on time.
Finally, here’s a vrief video with five other ways to improve your credit score – and within 30 to 60 days.