 To
a greater extent people have become increasingly dependent on their
credit. Whether you require it for a loan or mortgage or for purchasing
clothes and other services, there's no arguing the fact that credit
occupies a big part of our lives.
This is all the more reason for you to understand
credit reports, credit ratings, and scores. Here you will learn the six
significant facts about credit rating and some tips to help you get
that loan you're applying for, improve your credit history, and other
helpful hints for a better credit profile.
Creditors Rely on Credit Rating to Determine Credit Approval
Using credit is really just borrowing money that
you promise to pay back within a particular period of time. Now, at the
onset, you can see how significant it is for the creditor that you are
actually going to pay back what you owe him.
But the problem is that there is usually no
guarantee that the debtor - you - will pay back what you owe. At least,
not to the creditor, there isn't, unless, of course, you added a
mortgage to your loan to guaranty the credit. And even if there is such
a guarantee, it would still be better for everyone involved if the
debtor is able to pay his obligations on time.
This is why creditors are often very strict when
screening loan applications. They want to find out whether the person
is going to be a good investment by making his payments on time.
Now, one efficient way for creditors to find out
the possibility of a person paying back the money he or she has
borrowed is through the credit rating system or your credit score. It
is a statistical method that is based on various factors that relate to
income, employment, credit balance, payment habits, among others.
There are three main credit bureaus that issue
credit scores, namely Equifax, TransUnion, and Experian. But don't
expect that these agencies will give you consistent scores. As each
credit bureau uses different evaluation systems, each based on various
factors, it is most probably that your credit score issued by one
bureau is dissimilar from those issued by the other two.
Additionally, some lenders formulate their own
evaluation procedures to calculate a person's credit score. They may
also contact an independent credit reporting agency to issue credit
scores that use evaluation systems different from those used by the
credit bureaus.
There is no sure way to find out what factors a
credit bureau is using to calculate your credit score. However, there
are a few that remain more or less constant.
When calculating your credit scores, the following factors are often taken into consideration:
- Debt and payment history on credits, such as credit cards, student loans, consumer loans, car loans, among others
- Current debts
- Time length of credit history
- Credit type mix
- Frequency of applications for new credit or inquiries for new credit
- And other factors that may be taken into account, such as tax liens, judgments, and bankruptcies
All these factors can be determined from your
credit report. A break down of all these factors shows that your credit
rating is most affected by your propensity for paying off your debt as
shown by your credit history or previous credit performance.
If your credit rating shows that you pay off your
debts fairly quickly in the past, then your present credit rating could
get a boost up from that. In addition, maintaining low levels of
indebtedness, refraining from continuously applying for extra credit,
and having a long credit history will help your credit rating in the
long run.
Factors Considered in Calculating Credit Scores
When you borrow credit, the lender will want to
find out how likely you are going to repay what you owe. Therefore,
they contact any of the three national credit bureaus to get a copy of
your credit score.
The credit score predicts, based on your past
behavior, what kind of a borrower you are - whether you are the sort
who makes repayments regularly or one who often misses following up on
your obligations.
Typically, lenders will use your credit score to help them determine the following:
- What loan types you are eligible for
- Whether to approve your loan or not
- What your interest rate will be
The law does not mandate particular factors to
consider in credit scoring systems. Thus, credit reporting agencies are
more or less free to consider whatever factors they may feel is
significant to determine how willing you are to pay your bills.
But while the law does not specify what factors
to consider, it is however very particular about what may not be
considered in a credit score. Credit reporting agencies, credit
bureaus, and lenders are prohibited from considering the following
factors in credit scoring systems:
- Race
- Religion
- Gender
- Marital status
- Nationality
- Age
- Receipt of public assistance
If there is one thing you need to remember about
credit scores is that they reflect credit behavior patterns. This means
that no one factor will be considered as the only cause of a "risky"
score.
So even if you have a previous collection or a
bankruptcy, there is a possibility your credit score could still be
around the neighborhood of "average," which is in fact good and
entitles you to usually low interest rates.
As your credit behavior improves, so does your
credit score. There is no quick fix to improving your credit score. Any
short term improvements will not cause a risky score to improve
dramatically. So instead of relying on quick fixes and instant
solutions to poor credit scores, change your credit behavior by paying
your bills regularly and on time and refraining from opening any new
credit accounts.
Credit Rating is Indicative of Credit Behavior
Every time you apply for new credit, your credit
rating gets checked. As mentioned earlier, lenders want to know how
good a risk you are going to be when they do decide to lend you the
money required.
Any sort of credit application requires a credit
rating check - credit cards, mortgages, or even a phone hookup. The
financial theory is that increased credit risk means that a risk
premium must be added to the price at which money is borrowed.
In simple words, this means that if you have poor
credit rating, lenders will not turn you down at the initially but will
lend you money at a higher interest rate than the one paid by someone
with a better credit score. Higher rate, of course, is not a desirable
outcome since how high an interest you pay decides how soon you can pay
off the whole loan and how big a down payment you are required to pay.
For example take the following scenario:
'A', with a credit score of 700 gets an interest
rate of 5.61% on a loan. A pays $862 every month. 'B', on the other
hand, has a credit score of somewhere around 560. The lender offered
him an interest rate of 8.53% and he accepted, so that he is now paying
$1,157 every month.
The difference is clearly visible. For the same
loan amount, 'B' ends up paying more every month than 'A' does. This,
of course, has a large impact on how much B is paying for the interest
alone as the general rule is that payments will first apply to the
interest before the principal, which is the actual loan amount
borrowed.
Credit Scores Help Consumers
Because your credit rating or credit score is
indicative of your credit behavior patterns, lenders typically use them
to estimate the risk of having you as borrower. Just by studying your
credit score, they will know right away how much they are willing to
offer in terms of loan rates, interests, and monthly repayments. This
in fact helps speed up the approval procedure of a credit application.
Your credit score is not based on human judgment.
It is not based on cultural or demographic differences among people.
The guidelines used in determining your credit score apply to everyone
else's credit scores so that by using standard credits cores, lenders
are able to treat each consumer impartially.
Your Credit Report is Key to Your Credit Rating
Your credit rating is a fragile thing. And as
credit is very important these days, you in fact cannot afford any
mistakes or errors that could negatively affect your credit rating,
ergo, your chances of getting approved for additional credit.
To protect your credit from any damage, review
your records at least once a year. The US Congress has recently amended
the Fair Credit Reporting Act (FCRA) by including a provision that
provides for the issuance of free credit reports to consumers from any
of the three national credit bureaus - Experian, Trans Union, and
Equifax.
You can get your copy of your free credit report
by logging on to the AnnualCreditReport.com website and ordering a copy
online. Alternatively, you can contact any of the numbers and email
addresses provided in the Consumer Alert page of the Federal Trade
Commission (FTC) website.
The free credit report may come from any or all
three of the national credit bureaus. Though, if you order directly
with these bureaus, they may charge you a small fee. So to ensure that
your free credit report remains free of charge, order yours from the
website given.
Review your credit report and check for any
errors. If you find any, contact the credit bureau that compiled the
report. Under the law, the bureau is necessary to investigate your
disputed items within 30 days, at no cost to you. After investigation,
the credit bureau is further necessary to provide you with written
notice of the results of the investigation within five days, including
a copy of your credit report if it has changed based upon the dispute.
Improving your Credit Score Improves Your Chances of Getting Approved
A high credit score means you are a "low risk"
consumer. Lenders would be willing to offer you credit with low
interest rates, monthly repayments, and down payments. Thus, it is
significant that you improve credit score or at least maintain it if
you already have good credit rating.
Here are some tips to help you to improve credit score:
- Make loan payments on time and for the correct amount.
- Avoid overextending your credit.
- Never ignore overdue bills.
- Be aware of what type of credit you have.
- Keep your outstanding debt as low as you can.
- Limit your number of credit applications
- A longer history of good credit is favored over a shorter period of good history.
Credit is very important to our every day lives.
How you manage your credit affects your overall financial health. The
facts and tips we have provided you will help you to either maintain or
improve credit score.
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