What is a Credit Score?
We all have a credit score in some form. A credit score is a number between 300 and 85o which shows a persons’ creditworthiness. The higher the credit score is, the better a potential borrower will seem to potential lenders.
A credit score is actually based on our credit history, the number of open accounts we have, levels of debt, repayment history, as well as other financial details.
Lenders use our credit score to evaluate how well an individual will be able to repay loans within a timely manner. If you believe you will have to take out a loan or borrow money in the future, it is imperative that you know how to maintain good credit, and understand how lenders use your credit score.
How Credit Scores work.
Credit scores can significantly affect your financial stability. They play an important role in the decision a lender makes on whether to offer you credit. People who have credit scores below 640, are often considered being subprime borrowers. Lending institutions will often charge a higher rate of interest on subprime loans in order to compensate for the larger risk.
Lenders can also require a shorter repayment term, or even a cosigner for a borrower who has a lower credit score.
On the other hand, a credit score of 700 or more is seen as being a good credit score, and can often result in the borrower getting a lower interest rate from the lender. This means they will have to pay less money in interest over the life of their loan. Scores which are higher than 800 are seen as being fantastic and are even more beneficial.
Every creditor will define their own ranges for credit scores, however the average FICO score range is often used by most.
How is a Credit Score calculated?
In the U.S. there are three major credit reporting agencies; Experian, Equifax, and TransUnion. These agencies report, update, and store consumers’ credit histories. While there can be differences in the information they collect, there are five main factors which they evaluate when they calculate a credit score.
These five factors include; the payment history of the person, their total amount owed, the length of their credit history, their types of credit, and any new credit they have.
The payment history will account for 35% of the credit score, this shows whether a person pays their obligations on time. The total amount owed will account for 30% of the credit score, this section considers the percentage of credit that is available to a person that is in current use, this is also known as credit utilization.
The length of the credit history will account for 15% of the credit score, longer credit histories are considered to be less risky, as there is more data available to determine their payment history.
The type of credit that is used will account for 10% of the credit score. This shows if a borrower has a mix of installment credit, such as car loans or mortgage loans, as well as revolving credit such as credit cards.
New card is something else that accounts for 10% of the credit score, and it factors in how many new accounts a person has, as well as how many they applied for recently, which can result in inquiries as to when the most recent account was opened.
How do lenders use credit scores?
So considering all this, how do lenders use your credit score?
Well, when you apply for new or additional credit, lenders want to see how well you have fulfilled your credit obligations in the past to help them determine if they are safe to approve your request to borrow, it will also help them to determine the potential credit risk in lending to you.
Lenders will often use credit scores in order to help them determine your overall credit risk. Your credit score is built from the information in your credit report, as we mentioned above. When lenders look at your credit, a higher score will present a lower risk to lenders when they are looking to extend new or additional credit. Whereas a lower score presents more risk to lenders.
A credit score is simply an objective measurement of your credit risk at the point in time that you are seeking to borrow money.
They use credit scores, but often they will use it alongside other types of information, such as data that you will provide on your credit application form. These other forms of information can include your income, how long you have lived at your current reticence, any banking relationships you may have, employment status, and so on.
Depending on your lender, they will look at different areas of your credit report. Some lenders will not check your credit score, but this is risky and will result in a higher interest rate most of the time. Most lenders will check your credit score, however.
Many good lenders will check over not only your credit score but also your personal information such as names associated with credit, addresses and your date of birth. They will also check your current employer and your previous employers you may have listed on previous credit applications, any open loans or revolving credit, collection accounts, bankruptcies, any other credit inquiries and more.
They do not expect to see a flawless credit report, but they will hiss at a report that shows late payments, and they may reject the application or raise the interest rate to compensate.