Credit Scores and What They Mean

Aparna Iyer Jan 1, 2019
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Good credit scores that can be the key to availing loans at attractive rates of interest, can improve the overall quality of a person's life by helping him/her to fulfill the inherent desire for material comfort.
One often wonders whether information about bankruptcies, liens, judgments, and collections is really relevant. Credit inquiries by lenders, that could be the result of a person shopping around for the best rate of interest on loans, do not seem pertinent to an individual, who is not well versed with the computation of credit scores.
The reader, whose curiosity regarding credit scores and the computation of the same must be sufficiently piqued, may read on for clarification regarding credit scores and what they mean.

Significance of Credit Score

For the Lender

The method of computing scores using degree of indebtedness of a person, length of his personal credit history, availability and repayment of credit and frequency of applications for availing new credit are carefully documented and used to calculate credit ratings. The statistical basis for calculation was developed by Fair Isaac Corporation (FICO) in 1956.
It has become the basis for FICO, Empirica, and Beacon calculated by Experian, TransUnion, and Equifax, respectively. The next generation user-friendly credit scores, viz. FICO advanced risk score, Precision and Pinnacle are also computed by the same credit bureaus.
Credit scores lie between 300 and 850, both inclusive. Lender's prefer loaning money to people with credit ratings above 620 since higher scores are indicative of credit worthy borrowers. Since range is defined as the difference between the maximum and the minimum value one may say that the range of credit scores is 500.

For the Consumer

The rate of interest charged on loans, is a direct function of risk involved in the process of lending. As lenders use credit scores to determine credit worthiness of a borrower, a higher credit score will help the borrower procure loans at a favorable interest rate. The loan may be availed for buying a car, pursuing higher education or for buying a home.
One may also be approved easily for credit cards with low APR (Annual Percentage Rate). In fact, employees in positions of trust, may be assessed on their ability to manage finances on the basis of their credit report. According to the Fair Credit Reporting Act (FCRA), one is entitled to receive a free credit report, annually.

What Credit Scores Mean

It's evident that every person is straddled with three credit scores that may not be equal. The point of a credit score is to gauge the ability of the borrower to meet financial commitments, like loans.
Hence, a person with a poor credit score will find it difficult to procure loans at a reasonable rate of interest, since he/she is considered a risky investment. Borrowers are classified as prime, sub-prime, or shafted on the basis of their credit scores.

Credit Scores And What They Indicate

800 to 850:
It is an outstanding score. This score gets the creamier rates, certifying to the lender your credibility and reliability.

740 to 799:
An excellent score, the figure promises good rates for the borrower demonstrating confidence to the lender. It indicates a consumer is generally financially responsible when it comes to money and credit management.
670 to 739:
This range may necessarily not put you in a good stead. It may be harder to qualify for some types of credit in this range.

580 to 669:
This range is fair or average. Favorable rates may not be the option and you may have to chip in additional documents to assure the lender for better rate.
Under 580:
This, potentially, is a threatening credit score range. Your low credit score speaks of the degree of creditworthiness. It is this factor that demonstrates the individual is a risky or sub-prime borrower.
A shafted borrower is has score in the lower end of the range, somewhere below 560. Credit score, in the range of 680 - 850, assures of being qualified to avail loans at the prime rate of interest. A sub-prime borrower, with a score that lies below 620, would have to present a really strong case especially in the aftermath of the sub-prime crisis.

Improving Credit Scores

One can hope to improve one's credit score by punctually paying off the balance on the credit card at the end of each billing cycle, without being tempted to discharge just the minimum obligation. Existing lines of credit should not be canceled, since doing so will increase the debt utilization ratio.
The ratio between the outstanding balance and the amount of available credit is known as the debt utilization ratio. Again, increased credit limit will result in lowering the debt utilization ratio. A low debt utilization ratio is good for the credit score while a high ratio impacts the score negatively.
Keeping track of inaccuracies in the credit report, paying off debts using lines of credit that are not revolving and limiting credit inquiries can contribute toward a good credit rating, ensuring that the borrower can avail cheap credit without any further constraints.