You are probably aware of the importance of credit in today's financial scenario. Almost every financial transaction that you undertake will involve credit in some manner. Hard, liquid cash is obsolete and credit worthiness is what helps lenders decide how much credit to extend and to whom.
This reality has brought out the need for a universally accepted means to evaluate a person's creditworthiness. The three main credit bureaus - Experian, TransUnion and Equifax - that calculate credit scores adopted a rating system developed by FICO (Fair Isaac and Company) and at present, is the commonly accepted measurement of a person’s creditworthiness.
Credit Score Ratings Explained
Credit rating scores are independently calculated by various lenders. Some lenders may choose to calculate your ratings based on their own methods hence a good score differs with each of the credit bureaus, it is impossible to lay down a rigid structure, though the FICO score that ranges between 300 to 850 is regarded as universally acceptable standard.
|Credit Score||Relevance and Interest Rate|
|300 - 599||Extremely poor. Exorbitant rate of interest.|
|600-649||Poor. The highest rate.|
|650-699||Average. Relatively high rate.|
|700-749||Above average. Reasonable rate.|
|750-799||Good. Low rate.|
|800-850||Excellent. Lowest interest rate possible.|
Factors Considered for Credit Score Ratings
Your rating will be an independent entity and it is completely different from your credit history or your credit report. These are the various factors that a lender may take into consideration in order to calculate your credit score.
Payment History: Your entire history of payments is studied and your ability to repay loans at the right time is carefully analyzed.
Amounts Due: Your payment history would be incomplete without comparing it with the total amount that you are due to pay.
Length of Credit History: The more amount of time that you have been extended credit to, in the past, aids in the decision-making process for the present.
Types of Credit: This is where your credit portfolio and credit mix come into the picture. The more diverse your credit portfolio, the greater will be your score.
New Credit: The greater the amount of new credit that you acquire in a short period of time, the more suspicion you arouse. This will negatively affect your credit score.
As mentioned earlier, your credit report and score are two separate entities. Credit score ratings will always be calculated on the basis of your credit report. The credit report is simply a record or a journal of your past dealings involving all forms of credit. Your entire credit history will be chronologically listed in the credit report.
Note that bankruptcy will be visible on your credit report for a period of ten years, and most of the time, your credit report lists out details of the last seven years. Each of the three credit bureaus own a copy of your credit report and individually derive your credit score. As a result, you may have three separate credit scores.
Some of the details that are easily accessible on your credit report areas follows.
- Payment History
- Credit Inquiries
- Credit Utilization
- Current Credit Accounts
Whenever you approach a bank or any financial institution for a loan or for some form of credit, it is your credit score that will determine the rate of interest to be charged. By extending credit to you, the lender is exposing himself to some form of risk. Thus, the lender needs to substantiate that risk in some manner.
A person with low credibility is a higher risk for the lender, and so he is charged a higher rate of interest. With this knowledge in mind, you can now start improving your credit score, and thereby you can set realistic financial targets for yourself and know what to expect when you go looking for credit from various sources.