A person’s credit history carries a lot weight when it comes time to apply for a loan or a credit card and even for a job in some instances. When viewed in its entirety, a person’s credit history boils down to a single score that tells potential lenders and creditors about credit worthiness and the amount of risk a person poses in terms of making good on borrowed money.
Good scores make it easier to get approved for a loan. Having a good credit score also reduces the amount it costs to borrow money and obtain credit.
What Does The Score Mean
A credit score represents a mathematical formula that’s based on years of payment histories from various lending institutions, credit card companies and utility companies. The general scale used to assign a score runs from 300 to 850. The formula used to tabulate a score examines how consistent a person has been in paying off past debts.
The higher the score the better the credit rating, so lenders can gauge the type of risk involved with lending to someone with a particular score. In order to protect their assets, lenders base their interest rates on the amount of risk they take on when lending out money or credit. So, people with good credit scores carry a low risk profile, which gives them access to low interest rate charges.
A true credit score reflects a person’s credit worthiness from a lender’s standpoint. And while no official standard guideline is in place, someone with a score of 720 or above is considered to be in good standing. This makes getting approved for a loan or a credit card an easy process. It also helps to keep interest rate charges low when compared to people with scores below the 720 mark.
In terms of credit worthiness, lenders typically go by a general range of scores that fit within different categories. Scoring categories can vary depending on the particular credit guidelines a lender follows. In general, these categories break down into:
· Excellent 740+
· Good 680 – 739
· Average 620 – 679
· Poor 560 – 619
· Bad < 559
The lower the score the higher interest rate charges and the less likely a person is to qualify for a loan or credit line. In effect, these categories describe how good an interest rate a borrower can expect. So, good scores garner good interest rates while excellent scores provide the best interest rates available on the market.
Credit Score Factors
Someone with a true credit score has demonstrated a pattern of paying existing debts off in a timely fashion and in accordance with whatever repayment terms were in place. Factors affecting a credit rating include past payment histories as well as a person’s current debt-to-income ratio. Debt-to-income ratios compare the percentage of debt a person owes based on the amount of income earned.
Credit history also affects scores in terms of the length of time a person has had credit. A long, continuous history of good credit helps to improve a person’s overall score. In other words, credit histories ranging a decade or more give lenders more information to go in terms of credit worthiness.
The types of debts listed on a credit report also impact a person’s score with lenders preferring a variety of loan types. So, someone who has paid off a business loan, credit cards, a home loan and a car loan will have a better score than someone with a series of same-type loans.
And while applying for credit and loans helps to keep a person’s credit record active, too much activity can have a negative effect on the overall score. This is especially true in cases where a person is denied for one or more loan or credit applications.
As non-standardized guidelines dictate credit ratings in general, a good credit score can fall at different points along the “Excellent” and “Good” categories used by creditors and lending institutions. So, one particular bank may consider 760 as a good score while a credit card company may assign an excellent rating to the same score.
Other areas where non-standardized guidelines may come into play include a person’s debt-to-income ratio. This means people with excellent ratings may only be able to get a “good” interest rate because of the amount of debt they currently owe.
In general, credit scores are generated by three main credit rating companies: Experian, TransUnion and Equifax. Credit rating companies may use different scoring systems when compiling individual credit scores. These conditions also contribute to the non-standardized process used to define what a good score is.
Lenders and creditors also have a say in how strict their own particular rating guidelines can be when determining whether a person is credit worthy. So getting turned down by a lender with unusually strict guidelines may not reflect the actual credit worthiness of the applicant when compared to other lenders or creditors.
Improving Credit Scores
It is possible to improve a less than favorable credit score by following a few simple rules. Paying bills on time helps to create a clean credit history, so eliminate late payments at all costs. Clearing off any collection agency reports on record can also help improve a person’s overall score.
When using credit cards, avoid maxing out credit account balances. Ensure all credit card debt is paid down on a regular basis and in a timely manner. The type of credit card can also affect a person’s score in different ways. Major credit cards help build a person’s credit, while store credit cards have little to no effect on a person’s overall credit score.
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