Imagine that you need a loan to buy a car, what do you do? Simple, you approach a bank. The lender will then go through some of your important documents, namely, your credit report, score, history, and ratings. The credit report contains sensitive information regarding your total debts, your annual income, and your record as a borrower. Credit history is a record of all your repayment records. The lender looks for late payments and defaults while checking this history. They then consider the credit ratings that indicate the time period within which the borrower will be able to repay a particular loan. This figure is basically derived on the basis of credit history, and factors such as income and the current debt to income ratio.
For example, a R1/I1 rating means that the borrower will be able to repay the said amount in 1 month. The alphabets are basically codes for the types of credit and loans; R for revolving credit, M for a mortgage loans, and A for an auto loans. The score is then calculated on the basis of all these factors combined. Thus, the better your report, history, and rating, the better your score will be. The credit score, unlike the credit rating, is a single numerical figure and a total of almost all credit reporting aspects.
How is a Credit Score Calculated?
The credit score that is analyzed by your lender is usually derived from a mathematical model, that is provided by Fair Issac Credit Organization (FICO). The FICO provides several different mathematical models to credit reporting agencies and bureaus. In the United States, there are three main credit rating organizations; Experian, Equifax, and TransUnion, who cater to the lender's need for credit reports and score. The drawback of such a situation is that, every agency uses a different system to churn out scorecards and eventually supply credit reports. Hence, there are at least 3 different credit scores of a single person. Experian uses the Experian-Fair Isaac Risk Model, while Equifax uses Beacon, and TransUnion uses FICO Risk Score - Classic Model.
As the end result, there are 3 different scores (which numerically speaking, are not very different) and reports that a lender, on an average, will have to refer to for every case.
What is a Poor Credit Score?
The concept of the mathematical models that have been developed by FICO is fast gaining importance in the lending sector. The credit score figure is the most important element of the credit report. The score which has been calculated on the basis of FICO formulas, ranges from 850 to 300, the best being 850, and worst being 300. There are also some rare instances, where people have scores that are below 300.
A score that ranges from about 580 to 600 (+/- 20) is considered poor. This score is not exactly horrible, but is definitely making your credit report fat with unhealthy entries. This score means that you will have to pay a large amount of interest, premium, and not to mention, a commission to the lenders for any type of loan.
It must be noted that even if you have a bad credit, repaying a loan on time will help you improve your credit score, which will in turn help you fetch favorable terms and conditions, and lower rates of interest.