Banks, credit unions and other institutions that extend credit to consumers need to have some sort of benchmark on which to gauge particular individuals' creditworthiness. For this reason, credit bureaus keep track of consumers' financial history by collecting information about their outstanding debts and their tendency to make required payments on time. While this system lowers interest rates for consumers by allowing lenders to make reasonable decisions, it does have its drawbacks at times.
Incorrect Reporting
Although the credit reporting system is very thorough and tends to be accurate, inaccuracies can exist. Some companies, either due to a mistake or unethical business practices, do sometimes falsely claim that consumers owe them money. If the consumer refuses to pay, this claim can result in a whole series of negative items on a consumer's credit report. Gone unnoticed, such an incident can take a credit score that is otherwise good and push it down into the range of poor credit. However, consumers do have options in this situation. All three of the major consumer credit bureaus in the United States allow you to contest items that appear on your credit report. If they believe that a particular item is incorrect, they will remove it.
Incomplete Assessment of Financial Responsibility
Although a credit report -- and the numerical score that comes with it -- is an extensive assessment of your financial stability and responsibility, it is not perfect. One reason for this is the fact that credit reports depend so heavily upon loans and lines of credit. Not wishing to pay interest rates or risk running up credit balances that they cannot repay, some people prefer not to get credit cards or loans at all, instead saving up for any expensive items they would like to purchase. Such behavior shows a high level of financial responsibility, especially when credit cards and loans are available. However, such a history of financial responsibility does not show up on a credit report.
The Effect of Hard Inquiries
Lenders, credit card companies, employers and other parties have access to your credit score. They can make inquiries to judge your financial stability through this process; some of these inquiries are soft inquiries, while others are hard inquiries. Companies make soft inquiries as a part of marketing to see which consumers may qualify for their products and services; credit card companies make soft inquiries frequently. Such inquiries do not affect your credit score. Hard inquiries, on the other hand, are inquiries in which you apply for a loan, line of credit, employment or something else for which the other party would need to check your credit. Every time you authorize a hard inquiry, it has a negative effect on your credit score for six months. While doing it once has little effect on your credit score, doing it multiple times within a short period can have a substantial effect, significantly lowering your credit score even though your debt capacity and tendency to make timely payments remain the same.
A Cycle of Problems
Suppose a man has various debt obligations that are within his ability to pay, but then the company he works for goes out of business. Unable to immediately find a job, he cannot pay his debts. Months later, he finds an available position for which he feels he is qualified. He applies for the position, but upon checking his credit history, they decide not to hire him because they feel that his recent inability to pay debts shows that he is unreliable and irresponsible. This results in continuing unemployment, which results in a continuing inability to meet financial obligations. Many feel that this system of credit reporting is unfair, overlooking valid reasons for failure to meet debt obligations and directly protracting a tendency of financial instability.
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