Every lender or lending establishment wants to ensure that they’re making a sound decision by offering lending services to prospective clients. But It’s a borrower’s responsibility to convince lenders they’re trustworthy enough to handle repayment of a loan or credit card.
This is where “credit scores” come into play.
Banks and lenders evaluate how much a client can effectively repay and those decisions also effect the amount of credit extended and what interest rates are charged. To do this, they use a variety of models to create a credit score.
A credit score is a piece of information that takes into account someone’s credit history; and the factors involved include repayment history, total debt load, available credit and income.
It means your reputation as a borrower, determined by the client’s history of staying on top of their loan management and credit cards, because before lenders would sign off an loan with a client, or before a lending card company would offer a credit card, they want to be sure about your credibility on loan payment through your credit history.
Banks and other lenders use a credit score when they apply for any loan such as a student loan, line of credit business loan, or mortgage loan. For example, here are two individuals, Harry and Potter.
They are both of the same age, living in the same city, working at the same place and earning the same salary. Harry is financially responsible.
He puts a portion of his hourly earnings into a savings account every month, always pays his credit card bills on time, and has never missed a payment on the mortgage of his house and his student loan, Potter, on the other hand, is a financial mess.
He lives beyond his means, is always pushing his limits on his loan card, and he isn’t afraid to miss a payment or two to buy the things he wants.
Potter rents an apartment and hasn’t even paid off his Student loan yet.
Now both Harry and Potter came to a loan company looking for a loan.
Obviously, given both individuals’ lending history, Harry is more likely to pay back his loan.
On the surface, Harry and Potter look pretty similar; same city, same job, same income. Only when dug deeper would their differences be noticed.
A credit score is an ultimate tool contained in a credit record used by a lender or other lending establishment to achieve the aim of ascertaining the loan worthiness of a potential client.
However, this score is based on several criteria, which include; the credit history, several open accounts, total level of debt repayment history, currents loans, minimum lending payment in existence, instances of foreclosure or bankruptcy, and patterns of borrowing.
A lending loan score is included in a credit report, usually determined by the credit bureau. The major credit bureaus are EQUIFAX, EXPERIAN, and TRANSUNION.
Each credit bureau puts out a credit score or a FICO score, ranging from 300 – 850. The average score in America is about 711.
A score of around 740 and above usually get the best interest rates, and scores of about 620 and below usually prohibit a borrower from getting any loan at all.
The credit score depicts the loan worthiness of a borrower, meaning the higher the score, the higher the chances of a client getting an loan with little interest rates and vice versa.
For instance, given Harry and Potter’s lending history, Harry’s loan score would be about 800, while Potter’s would be close to 550.
If they both need to borrow $1000, Harry will get an interest percentage price close to 5%, which is less, while Potter’s interest percentage price could be as high as 40%.
Elements of a Credit Score
An loan score is affected by varying factors with varying level of importance, and they include:
When a borrower makes regular and consistent on-time payment of a debt, it helps build up the client’s income score, which shows their responsibility toward funds incurred regularly and accordingly.
The way you pay your bills essentially means so much to the lenders and financial organizations because they want to know if you would and can pay back loans; this is highly essential as it accounts for 35% of a credit score makeup.
It’s not exactly about how much a client owes but how they use their loan cards monthly. For example, if you have five cards and the available limit is $25000, and a borrower uses only $1000, every month would constitute a bad credit score.
This factor takes up 30%, which is vital as lenders want to know that a client can handle a reasonable amount of debt without going off the rails.
Length of Credit History
This accounts for 15% overtime when credit is used wisely and reasonably. As a borrower opens up an loan card and starts to build their loan score, the first one that is opened should be ultimately kept opened as they add to the loan card’s longevity and build up the credit score.
Some 10% of this factor accounts for a credit score. This deals with how often a client solicits for a new loan.
When a client goes out to inquire about a car loan or a house loan, or even a student loan, these are instances of soliciting for a new loan.
They ultimately matter to lenders because it allows them to evaluate a client’s level of responsibility and ability to handle loans.
Types of Loans
Not all credit cards are created equal. Some take moderate interest rates, while some take exorbitant prices, promising an extra layer of security.
For instance, a loan for a mortgage from a bank is a better way to go than a loan from another loan institution.