Credit score can be described as a three-digit number expression based on a level analysis of individuals credit files, to represent the creditworthiness of a person.
How Credit Score Works
It’s based basically on a credit report; information normally sourced from credit bureaus. In other words, a credit score also known as credit rating is a three-digit number that`s designed to guide lenders understand your credit-worthiness. And they are issued by different companies.
Lenders like banks and credit card companies, use a credit score to assess the potential risk posed by lending money to consumers and to prevent losses as a result of bad debt. Lenders use it to determine who qualifies for a loan, credit limits and at what interest rate.
Lenders also use credit scores to ascertain which customers are likely to bring in the most revenue.
Credit scoring is not only limited to banks. Other organizations like mobile phone companies, insurance companies, landlords, and government departments and agencies adopt the same techniques.
Digital finance companies like online lenders also use alternative data sources, by way of calculation to arrive at the worthiness of borrowers.
Scores by most credit score companies range from a low of 300 to a maximum high of 850. This number is then used by lenders to determine how risky it is to give you a loan. In the nutshell, the higher your score, the more likely you will be mandated to pay back your loan on time.
Factors included in credit score
The credit score is based on five (5) factors. They include:
- Payment history (35%)
- The amount owed (30%)
- Length of credit history (15%)
- New credit requested (10%)
- Types of credit in use (10%)
The payment history is the most important factor in determining the credit score of persons. The credit company is looking at whether they`ve made all their payments on time. If they have any late payments, it considers how late they were (30, 60, or 90+ days), and if there were any charge-offs, debt settlements, or accounts that were forfeited to collections. Foreclosures and bankruptcies are also factored in.
The second most vital factor is how much individuals currently owe because lenders obviously want to make sure they`re not giving them more credit than they can handle. For example, someone who has a $10,000 credit limit with a $2,000 balance will rate better than someone with the same credit limit and an $8,000 balance.
Next important is the length of individuals` credit history because it discloses how long they`ve been using credit. A longer history is actually better, however only if it`s not carrying negative marks. Since their credit history only has a 15% weighting, those with a short, however, clean history can still get a respectable credit score.
Read on Money and Savings
Frequently requesting new credit lower score. This is particularly true if someone has made a significant number of requests in a short period of time. Lenders could see this as a warning that they have in financial trouble or are preparing to rack up a lot of debt.
What is considered a good credit score?
Lenders generally place individuals in a category depending on their credit score range.
Bad = 300 to 629
Fair = 630 to 689
Good = 690 to 719
Excellent = 720 to 850
The range of individuals fall into will impact their lives in many ways. The most obvious occurs when they need to borrow money. Not only will their credit score impact whether they`re approved for a loan, but it also affects greatly the interest rate they`ll have to pay.
For instance, if a person with excellent credit applied for 30-years $300,000 fixed mortgage and was offered a rate of 3.6 %, they would pay approximately $190 per month less than individual with poor credit that was offered the same loan at a 5.2% rate.
Over the life span of the loan, this small difference would add up to a huge $70, 000 in additional payments – all due to a difference in credit score.
The Significant of the credit score goes beyond lending decision. Majority of people don`t realize that credit score impacts many different areas of people`s life including employment, insurance, and housing.
Approximately half of the employers check the credit of potential applicants before offering them a job. Many landlords will check credit score before renting out a house or an apartment. A bad credit score can cause a denial of someone application or Landlord could require them to put down a larger deposit.
Majority of mobile deals are contingent on a good credit score, and a bad credit score could prohibit them from opening a mobile phone contract at all. A bad credit score could also result in a substantial up-charge on their auto insurance premiums.
When you`re applying for a credit card, scores in the good to the excellent range will grant you greater access to offers, such as zero-per cent interest, higher cash-back, and sign-on bonuses offer.
A credit score of 700 or above is generally regarded as a good one. A score of 800 or more on the same range is considered to be excellent. Majority of credit scores are in the range of 600 and 750. Higher score warrants better decisions and can make creditors or lenders more confident that you will repay your future debts as agreed.