How Credit Scores Work

Introduction

A credit score refers to a number used by third parties, most lenders in order to determine the risk associated with offering you credit. A credit score is one strategy that is employed by credit card companies, banks, and other financial institutions to assess your capabilities in paying off the debts you accumulate. Higher credit score signifies that your financial circumstances and credit history show ability and willingness to pay-off loans that you might get approval for.

Sometimes back, lenders used to manually go through the credit reports, page after page on details regarding your borrowing history. Whenever you are given a loan, your activities are reported by the lender to the credit bureaus and financial information is then compiled for credit reports. Perusing through the report was then time-consuming and one would easily miss some critical points.

How Credit Score may affect your Financial Product

Credit score may affect you in two different ways. Whether you are legible for an approval for a certain financial product, and the interest you should pay in case you get an approval. You realize FICO score is used by most of the credit agencies to measure creditworthiness, especially in Canada. The higher the FICO score the more the chances of securing an approval for a loan or credit card, and this also lowers the rate of interest associated with that particular card or loan. A lower score may make you get disqualified for services or product completely and increase your interest rates.

Most of the credit cards, especially the highly lucrative rewards cards, their cards are only offered to those consumers able to meet the minimum credit quality. Best credit cards are usually marketed to consumers following their excellent credit scores. A good credit score is very important because it can be used to determine the range of options you choose from. The interest rate for a specific card is inversely related to your credit score whereby higher creditworthiness is given lower rates of interests and vice versa.

On the auto loans and mortgages, lenders behave the same way. Your credit score will always be used as the component of measure whether a bank chooses to approve your loan or not or it may also force you to bring in some other additional concessions for the approval.

Components of Credit Score

-FICO Credit Score

This verifies the amount of debt you have, how much were you able to pay in the past and so forth. Scores range between 300 – 850 and they are composed of the following components.

-35% history of payment – this helps to know whether you have defaulted on loans or missed payments.

-15% Length of the Credit – Are you borrowing for the first time?

30% Amounts owed – how much do you owe financial institutions?

10% New Credit – have you engaged in numerous loan application in the past?

10% Type of Credit – How healthy is the mix of your different types of credit?

-History of Payment

The best way to consider your history of payment is by reviewing the track record of all the things you’ve had faults when it comes to credit and be able to measure your behaviour in debts. A history with negative information shows that the person experiences challenges in meeting the debt obligations or rather he/she has a high-risk attitude when it comes to credit. These are signals to the lender that they need to be more cautious when considering to make an additional credit available.

-Late Payments

Another problem faced by the consumers in payment history is the late payments. Being late for a monthly payment of your loan or credit card is likely to cause a negative change on your credit score.

Other Types of Credit Score

-Alternative Credit Scores

This is based on similar information, although there are those individuals who don’t have a history of borrowing, maybe because you are young or you have never borrowed. The alternative credit score considers other sources of information for example whether you pay bills in time.

-Other Score types

On this, the lenders may use a combination of different information from credit reports and some other sources. For example, they may use the information you provide on the loan application form to determine your creditworthiness.

Conclusion

Your credit score will be defined by how much you have paid or didn’t pay your bills in the past. Most of the financial organizations such as utility lenders, banks, mortgage lender, employers etc will use a credit score in order to predict your future financial obligation. Any time you want to borrow some money or other services, your credit score will always be questioned. This is the reason why ensuring a good credit score is crucial.