What Is Credit and Should I Freeze Mine? Pros and Cons Explained

Credit is very important to understand, as it lays the groundwork for your financial success. If you want to save money and leverage assets, it’s an essential component of doing business.

When you have what the industry considers good credit, you are able to do and have the things you want. Alternatively, if you have what is deemed as bad credit, it will be difficult to be approved for the things you need, and/or you will pay a much higher interest rate on those items. 

We do not start off with good credit. It must be managed and nurtured appropriately to grow your credit into good standing. We must prove our creditworthiness over time by showing we will fulfill our end of the bargain. Once you have established history showing you’re creditworthy, lenders will consider you low risk to borrow funds.

Even if you don’t plan to apply for a loan in the near future, it is imperative to protect your credit from identity theft. Identity theft occurs when someone steals your personal information and opens a line of credit (or more) in your name. This can have catastrophic consequences to your financial life for years, so it is very important to know the warning signs and take immediate action.  

Credit Defined 

Credit is an agreement between a lender and a borrower to borrow funds or access goods and services on the basis that they will pay it back later, usually with interest.

The lender is a financial institution, group, or individual that loans money to a person or business, with the expectation of having those funds paid back on a specified schedule.

The borrower is the person or organization that needs a loan for a sum of money, with the understanding they’ll need to pay it back.

Lenders, service providers, and merchants (also known as creditors) will issue a credit based on creditworthiness. They measure creditworthiness by your credit report, which helps them assess the risk involved, or how responsible you are at managing your debts. 

Credit Report

A credit report is a statement that summarizes your credit activity, such as the number of credit accounts you have, payment history, and balances. It also contains public records such as liens, foreclosures, or bankruptcies. 

There are three nationwide credit reporting agencies or credit bureaus; Equifax, Experian, and TransUnion. Once you have established your first form of credit, these credit agencies will have a credit report on file for you. 

Your credit report is how these agencies calculate your credit score. Lenders will use your credit score to determine creditworthiness before deeming a loan amount or interest rate. New accounts typically need between 3-6 months of activity before they can be calculated into your credit score.

Credit Score

There are a variety of ways to calculate a credit score, but the most widely used method for lenders is the FICO score, created by Fair Isaac Corporation. FICO scores are calculated using a formula that uses different pieces of data from your credit report such as, payment history, amount of debt owed, and length of credit history.

Credit scores tend to fluctuate somewhat from month-to-month as the information in your report changes. Scores range from 300 (low) to 850 (high), but most lenders consider a “good” credit score to be in the range of 670-739. The higher your score, the less risk assessed by lenders, so they are more likely to approve you for a larger loan and/or a lower interest rate. 

There are a large number of free platforms available to check your credit score. It is recommended that you stay on top of your credit report and review it for errors periodically. If you come across inaccuracies or a credit line that doesn’t look familiar, you should contact one of the nationwide credit reporting agencies immediately to dispute the issue.

If you find suspicious activity on your report, you have the option to add a preventative measure called a fraud alert, which adds an extra level of security when attempting to open new accounts in your name. It is free and lasts for one year.

Security Freeze 

A security freeze, commonly known as a credit freeze, is another tool to protect yourself from identity theft or fraud. With a security freeze, creditors are not able to access your credit report to open new accounts. This will prevent you or identity thieves from opening new lines of credit in your name until the freeze is temporarily lifted or permanently removed.

Under a recent federal law, security freezes are now free nationwide. You’ll need to file a security freeze request with each of the three major credit bureaus for it to be effective. After receiving your request, you’ll receive a PIN number to be used each time you want to freeze or unfreeze your account to apply for credit. It’s almost like locking up your credit in a vault until you need it again. In most states, the freeze lasts until you have it permanently removed. There are a few states in which the freeze expires after seven years.

A credit freeze will not impact your credit score or have any effect on your current credit accounts. If you decide to apply for a loan or a credit card during the freeze, you’ll need to have it lifted temporarily. Be sure to give yourself enough time to complete the loan application or underwriting process. 

Pros and Cons of a Security Freeze

Pros

  • It’s a great tool used to protect yourself from fraud or identity theft, as it is guaranteed by law. There is also something called a credit lock, but it is not regulated by the government and may require a fee.

  • It’s totally free! Federal law allows you to activate and remove a security freeze on your credit report with each credit bureau at no cost.

  • It’s a very simple process. With the new law we mentioned before, all three credit bureaus are required to maintain websites where consumers can request a security freeze online. If you prefer, you can also call or submit a request in the mail. 

Cons

  • You may need to provide a PIN each time you want to allow a creditor to have access to your credit report. Two of the three bureaus will allow you to answer a series of security questions to unfreeze your account, but at least one will require the PIN.

  • It’s extra work for you. The Federal Trade Commission requires the bureaus to unfreeze your account upon request (within one hour if done by phone or online, three days if submitted by mail). If you want to apply for a new account, you’ll need to contact each of the bureaus separately, which can be a hassle.

  • It does not guarantee protection from all types of fraud. A freeze will prevent an identity thief from opening new lines of credit, but it does not protect your existing accounts. You will need to monitor your credit report for discrepancies on a regular basis if you think one of your accounts has been compromised. 

Since security freezes are free and don’t affect your credit score, there are not many drawbacks to using the extra security measure if you think it’s necessary. 

Summary 

Keeping your credit and personal information safe is extremely important. Your credit score is vital to your financial success. If you have good credit, you’ll have no problem getting approval for a loan. If your credit score is low, it’ll be a challenge to get approved for things, and you’ll end up paying more in interest.

You should take advantage of credit monitoring services that provide access to your credit report on a regular basis. Keep an eye out for suspicious activity and dispute any discrepancies immediately. A fraud alert can help create an extra level of security from accounts being opened in your name without your consent.

A security freeze is an additional tool used to safeguard your credit. It restricts access to your credit report from all creditors until you temporarily lift or permanently remove it. Thanks to a recent federal law, it’s free and doesn’t affect your credit in any way. With this extra measure, you’re still able to open new accounts by providing a special pin or answering a series of security questions. 

There is not much downside to activating a security freeze if you think your personal information may be at risk. At most, you may need to put in some extra effort before you can apply for a loan, but it’s a small price to pay in order to avoid the consequences of identity fraud. 

 

Sources:

https://www.identitytheft.gov/warning-signs-of-identity-theft

https://www.consumerfinance.gov/ask-cfpb/what-is-a-credit-report-en-309/

https://www.myfico.com/credit-education/credit-scores

https://www.ftc.gov/news-events/press-releases/2018/09/starting-today-new-law-allows-consumers-place-free-credit-freezes

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