If a lender or financial institution has to give you a loan, your credit score indicates the risk he/she will be carrying for lending you money. It directly affects the terms and interest rate at which you will get a loan. Read the following article to understand what this entity indicates.
With the widespread use of credit cards and loans, lenders and companies began to search for a method to ascertaining the risk involved in lending a particular loan or giving a particular credit card. The concept of credit rating agencies and reporting thus came up. This mechanism is quite simple; the agencies maintain databases for bankers, lenders, and credit card companies. Such databases contain related information of every individual who has borrowed a loan or has a credit card. In order to make the system more successful, lenders, bankers, and card companies also report all the loans, installments, and payments to the agency.
Thus, every individual has a ‘file’ known as a credit report that is stored with the credit reporting agency. The report is principally divided into 3 parts that are considered by the lender: some personal information such as assets and current salary, the credit history, and finally, your rating or rather, the calculation of your credit worthiness. The most important part of the credit rating is the score that numerically sums up the report review. Maintaining a good one is thus very important.
One must also note that an individual can have more than one score and credit report since there are multiple agencies reporting credit information. There is also a chance that your report contains some or the other mistake, upon which you can initiate a credit dispute with the company. Experian, Equifax, and Transunion are three prominent credit reporting companies that provide reports in the US. These companies also permit one report, free of cost, every year to the consumer. It is essential that you check your reports every year.
In the United States, the most common credit score rating scale is the FICO score range. It is a three-digit numerical that ranges from 500 to 850. From the point of view of comparison, 500 is the lowest score while 850 is the best. The score is made up with the help of several different facts and figures. The mathematical model that is used to calculate it is provided by FICO (Fair Issac Corporation). Experian uses Experian/Fair Isaac risk model, while TransUnion makes use of EMPIRICA mathematical model. Equifax, on the other hand, uses BEACON.
Following are the constituents of score:
- Payment History (35%)
- Amounts owed at the movement (30%)
- Length or size of the credit history (15%)
- Different types of credits (10%)
- Newly borrowed credits (10%)
FICO mathematical models divide the scores in 6 categories: 760 to 849 (excellent), 700 to 759 (good), 660 to 699 (average), 620 to 659 (fair), 580 to 619 (poor), and 500 to 579 (bad). These are principally used to decide the approval of the loans and interest rates. The highest score possible, 849, gets the best terms of interest and also the least possible interest rate, while a bad one gets higher interest rates.
Thus, in order to get the best possible interest rates and terms and conditions, start improving your score. Apart from this, also make it a point to use least possible credit facilities such as loans and credit cards. Lastly, make all payments of bills and installments, perfectly on time.