- Confusing words can discourage some people from trying to understand their credit report.
- The term “authorized user” applies to children, partners or friends who are added to your account.
- People are also confused by the term “secured credit”, which is credit secured by collateral, such as a house or a car.
- Read more stories from Personal Finance Insider.
Trying to understand your credit report can feel like learning a new language.
Your credit report contains information that explains why your credit score is what it is. Whether you access your credit report for free or use a paid service, it can seem daunting to read your credit report, let alone take steps to improve your credit score. But understanding your credit report can help you identify key action items to increase your score.
We asked Dominique Broadway, personal finance coach, to Finances demystified for three common terms on credit reports that most people find confusing.
1. Secured and unsecured debts
Broadway urges people to learn the difference between secured and unsecured debt. Secured debt, such as a mortgage or car loan, is backed by assets that serve as collateral. For example, an auto loan is secured by a car that a lender can repossess if the borrower misses too many payments.
On the other hand, unsecured debts like personal loans and credit cards do not require any collateral. According to Broadway, “Having a healthy mix of different types of credit — secured and unsecured debt — can be very important to your credit score.” Regularly paying off different types of debt on time can result in a higher score.
2. Authorized User
An authorized user is someone, usually a family member or friend, who is added to someone else’s credit card account. Since the average length of open accounts is factored into your score, parents can add their children as authorized users on credit cards to give them a head start on building credit.
If you are a parent and add your child as an authorized user on your account, it is important to understand how this may affect your credit. “When you co-sign someone else’s debt,” Broadway told Insider, “it can affect your debt-to-income ratio.”
Your debt-to-income ratio is the amount of debt you have relative to your income. A high debt-to-equity ratio can negatively affect lenders’ decision to lend you money for a house or car in the future. If you have an authorized user on your account that uses your shared account to the maximum, your debt to income ratio may be higher.
The Authorized User’s credit report may also be negatively affected if the person who owns the account pays their bills late. “As an authorized user, you are not responsible for the debt,” Broadway says, “but it does reflect on your credit report.”
3. Debt utilization rate
Your debt utilization ratio is not the same as your debt to income ratio; it is the amount of money you have borrowed compared to the amount of money you are allowed to borrow. For example, if you have $10,000 of available credit and you have used $9,990, your debt utilization ratio is 99%.
Unlike your debt-to-equity ratio, your debt utilization ratio always shows up on your credit report, and “this percentage can have a huge impact on your credit score,” says Broadway. She explains that the higher your debt utilization ratio, the more it can negatively affect your credit score.
If you can’t afford to pay off your existing debt to lower your debt utilization rate, Broadway suggests calling your credit card company to see if you qualify for a credit limit increase. which can also reduce your utilization rate.