If you have ever used a credit card or borrowed from a creditor you will have a credit history.
When you use a credit card or take out a loan, the creditor sends information about the frequency and amount of your payments to a credit reporting agency, like Equifax or TransUnion. Such credit reporting agencies, or credit bureaus as we like to call them, collect information about you and how long it takes you to pay back money you have borrowed. Such information is your credit history. It influences how creditors (banks) view you as a candidate for additional credit.
To understand how a credit history can affect a consumer credit score, we will showcase two scenarios with two different kinds of consumers. Consumer A earns a good income, owns a home and owns a number of credit cards. Consumer B earns a moderate income, neither rents or owns property, does not own a car and owns only one credit card. Let’s analyse the spending habits of each consumer to compare how their credit history affects their credit score.
Consumer A: credit history = high credit score
This consumer graduated university 5 years ago, owns a car, owns a condominium and owns 5 different credit cards. He has $5000 left to pay on his student loan, $10,000 left to pay on his car loan, $100,000 left to pay on his condominium mortgage and owes $8,000 in unsecured credit card loans. He makes regular payments on each of his loans each month and pays only the minimum payment on his credit card bills. He paints a pretty picture for creditors because he has a broad range of loan types and is consistent with his payments. By making only the minimum payments, he pays the bank a healthy amount of interest over an extended period of years. Such credit history formulates to a good credit score because it proves to the banks that this consumer is “credible”. Having a good credit score will prompt banks to offer additional credit allowances to the consumer to encourage increased spending power…which comes with increased interest payments. What’s the catch? Already trapped in a seemingly endless spiral of minimum payments, he may stretch himself too thin by taking on additional credit. After all, if you have more allowance to spend, won’t you spend more? Having a healthy credit history may lead to an endless road of payments and debt.
Consumer B: credit history = low credit score
This consumer graduated from university 5 years ago and takes public transportation to work. She was fortunate her parents were able to pay for her tuition. She lives by a budget to ensure her expenses do not exceed her income each month. She is using a saving jar to purchase a condominium and is living with her parents in the meantime. She has owned a credit card since she started university but does not use it regularly as she would prefer to use cash for making purchases. Her credit history will show her open credit card but few loan payments. Based on her less than active credit history, a creditor may refuse to lend her money if she applied for a loan. Why refuse a person how seems to be responsible with her money? In the banks minds she is not “creditworthy”. She has not used her credit card enough to build a “healthy” credit. A co-signer may be required in order to secure a loan. Her credit history would formulate a low credit score. In order to improve her credit score, she would need to use her credit card a few times a month and make regular payments. Her personal finance management seems to be savvy enough to keep her on track – she manages her finances responsibility and spends within her means. However, her decision to not use credit as much as Consumer A does penalizes her, by banks, with a lower credit score..
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