Credit Review: Definition, Purposes, How to Read Them

What Is a Credit Review?

A credit review—also known as account monitoring or account review inquiry—is a periodic assessment of an individual’s or business's credit profile. Creditors—such as banks, financial services institutions, credit bureaus, settlement companies, and credit counselors—may conduct credit reviews. Businesses and individuals must go through a credit review to become eligible for a loan or to pay for goods and services over an extended period.

What Is the Purpose of a Credit Review?

The primary purpose of a credit review in the eyes of creditors is three-fold: 1) to determine if the potential borrower is a good credit risk; 2) to examine a prospective borrower's credit history, and 3) to reveal potentially negative data.

To Gauge Creditworthiness

A credit review is a tool for examining someone's ability to repay a debt. Extending credit depends on the lender's confidence in the borrower's ability and willingness to pay back a loan; or pay for the goods purchased, plus interest, in a timely fashion. As a consumer, your credit report can mean the difference between being approved or denied for a loan.

To Examine Credit History

Your credit history is your financial track record that shows how you have managed credit and made payments over time. This history appears in your credit reports from the three main U.S. credit bureaus, Equifax, Experian, and TransUnion, which contain information from lenders that have extended you credit previously; including your payment history with each creditor and the credit limits or loan amounts associated with each creditor. Your credit history is captured into a single number known as a credit score.

To Reveal Potentially Negative Information

A credit review also can unearth any potentially negative information about your financial history—such as bankruptcy filings and monetary judgments—that is contained in public records.

Credit Reviews Also...

• Determine the size of the debt burden relative to earnings. A person's debt-to-income ratio (DTI) plays a large part in their readiness and ability to qualify for a mortgage. DTI calculates the percentage of your income that goes toward paying your monthly bills. The industry prefers a debt-to-income ratio of 43% because that is usually the highest DTI ratio you can have and still get a qualified mortgage.
• Check that a borrower still meets loan requirements. A creditor may want to establish that a borrower continues to meet a loan's criteria and standards—their financial circumstances could have changed.
• Offer a credit increase. Lenders generally review a borrower’s account every 6 to 12 months to offer borrowers with an excellent payment history an increased credit limit.
• Help to make employment decisions. Not all employers use a credit report as a deciding factor for hiring, but in certain industries—banking, real estate, and financial services—your credit report can help or hurt your chances of getting a job or license.

Why Check Your Credit Report Regularly?

Few things in life follow you as your credit report does. Your credit report is a financial snapshot that presents you to the business world. Other parties view it—generally with your permission—and so, of course, should you. By law, you are entitled to review the information in your credit report annually, and doing so does not affect your credit score.

An Impact on Your Life

Your financial history can affect how easily you can buy or rent a home; make big-ticket purchases like cars, appliances, and jewelry and pay over time; take out loans, and in some industries even get hired. Achieving and maintaining good credit requires work and attention to detail. Checking your credit report regularly can help to ensure that it paints an accurate picture of your finances.

Mitigate Any Negative Surprises

You want to make sure that your credit report does not contain any errors or negative surprises. If you do find errors, then you may correct them with the credit bureaus. If your credit history contains data that reflect you poorly, but which is true, then you should be aware of the issues so that you may explain them to potential lenders instead of being caught off guard. For additional protection from errors, consider using one of the best credit monitoring services.

Free Copies of Your Credit Reports Every 12 Months

You need to review your reports from all three credit bureaus—Experian, Equifax, and TransUnion—because the information between them may vary. Each credit bureau allows consumers one free credit report annually, through AnnualCreditReport.com.

Credit reporting agencies allow information to fall off of your credit report in time. Typically, negative information falls off after seven years, except for bankruptcies, which stay on your report for 10 years.

Know Your FICO Score

It's important to know your FICO score, too, and to check it from time to time. Having a good score increases your odds of getting approved for a loan and helps with the conditions of the offer, such as what the interest rate will be. Furthermore, having a low FICO score can be a deal-breaker for many lenders.

What Type of Information Does a Credit Review Collect?

Whether an individual applying for a mortgage or home equity line of credit (HELOC), or a small business applying for a loan, banks generally collect similar types of data in a credit review. When both lender and borrower are businesses, much of the evaluation consists of analyzing the borrower's balance sheet, cash flow statements, inventory turnover rates, debt structure, management performance, and the current market conditions.

Most prospective lenders will concentrate on the following fundamental characteristics:

• Capital refers to the money that is available to you to repay a loan via savings, investments, or other assets. Although creditors view your household income as the main source of repayment, any extra capital you show tells lenders that you manage your finances well, making you less of a credit risk.
• Collateral is something that you own that can be used to secure any loans or lines of credit that you apply for. When you take out a secured loan—such as an automobile or HELOC—you will pledge your asset as collateral.
• Creditors may consider certain conditions under which they would extend you credit—such as the interest rate, the amount of money you are borrowing, or even how you plan to use it. Some lenders may accept a lower level of risk if the results of the loan would contribute to the social good—such as funding low-income housing projects or incubator programs.
• Other extenuating conditions that a creditor may consider could include the state of the economy or different industry lending trends, such as the impact of the Great Recession on the mortgage industry in 2008.

The Bottom Line

A credit review details a person's or business's credit history and impacts almost every aspect of their life, from their ability to rent or buy a home or car, get a credit card, and sometimes even a job. Managing your credit profile by regularly checking your credit reports is prudent personal finance.