A credit score is the key parameter all lenders evaluate before making a decision about a loan approval. It is important for banks to know whether the client is trustworthy enough in terms of his solvency, reliability and financial stability. A credit score is a financial “passport” saying about the borrower everything, based on his previous history of taking and returning loans.
In other words, credit score shows the lender your level of credibility, so the lender can assume the risks he takes when giving you money.
Benefits of high credit score are extensive: it gives borrower wider range of advantages, from being offered bigger sums of loans, to paying a lower interest rate and having more flexible terms of loans’ repayment.
On the other hand, low credit score shortens loans options dramatically. Lenders simply don’t want to take a risk of not being paid back, due to the borrower’s low credibility and poor financial situation.
Below, we will highlight the key aspects of credit scores to help you understand everything about it.
How are credit scores determined?
There is a range of credit scores that determines whether your score is good, bad, or average. Different financial institutions set different scales of credit score determination. Still, there is a common scale, used by the majority of banks and non-bank lenders. This scale (or, sooner, a scoring algorithm) is called FICO scale, that stands for Fair Isaac Corporation. It is the generally accepted score scale in the USA.
- 629 and lower (to 300) – is a bad score;
- 630 – 689 – is an average score;
- 690 – 719 – is a good credit score;
- 720 and higher is an excellent credit score that gives the biggest number of advantages.
In some cases, especially when a person undergoes a bankruptcy proceeding, credit scores may plunge even below 300, which makes it almost impossible for this individual to get an unsecured loan. Yet, even with the “zero” credit score, a borrower can get a loan, provided by numerous online lenders (both private and corporate ones).
Credit score and credit report
Many people do not really understand the difference between the credit score and a credit history. First of all, credit history is a history of a borrower’s previous actions related to borrowing money: how many times he did apply for loans, how many times he actually received and repaid loans and whether there were any issues related to repayment delay and so on. This history is reflected in a personal credit report.
At the same time, credit score is a brief numerical summary of a borrower’s creditworthiness, based on his credit history. Credit score changes all the time, depending on the changes in credit history: each time the individual applies for a new loan, his credit score changes. Below we will analyze what factors make your credit score do up and down. Also, take a note, that some lenders may use different counting algorithms for evaluating your credit scores.
What makes your credit scores rise and fall?
Five key criteria build a credit score:
- The history of a borrower’s payments on previous loans. The highest score is given to the borrower who made all payments on time. Each delay with payments withdraws some weigh from the overall credit score.
- The total amount of currently and previously owed money. The larger the sum of previous loans that were paid off fully, the higher the score.
- The diversity of previous loans – types of secured and unsecured loans. The more diverse your credit report, the more reliable and credible you look in the eyes of potential lenders (especially when it comes to unsecured loans).
- The length of the overall credit history: the longer your history the higher the scores.
- New credits (current loans ) and amounts of borrowed money. Obviously, the bigger the number of currently unpaid loans, the lower the credit score, even if you make payments timely. The logic is simple: the more loans you have, the smaller your financial resource is (you have to give away more money from your salary, so risks that another loan will be failed increase).
Common myths and facts about credit scores
Myth: Every time a person applies for a new loan, his credit score goes down.
Truth: It can be true only in a case of a multiple applying for loans in a very short timeframe that indicates a person is in a financial desperation and urgently seeks for money. In all other cases, a credit score either stays the same or drops just a little bit.
Myth: A record about previous low credit score will affect my following applications
Truth: Totally false statement. Many people are afraid (especially people who’ve been through bankruptcy), that their low scores will haunt them forever. The truth is that lender pays attention only to the relatively recent credit history, without referring to a person’s fails that took place years ago.
Myth: Credit score is the only parameter that defines whether I’ll receive loan or now
Truth: Credit score is important, but not the only criterion lenders pay attention to. Your occupation, the salary, financial situation of the spouse (if you both have joint loan/loans) also counts.
Myth: Family members and their financial situation affect one’s credit score
Truth: As long as your family members are not your co-signers or joint borrowers on some of your loans, their financial situations and credit scores don’t affect your scores whatsoever.
Myth: Tracking own credit score affects it in a negative way
Truth: You can send inquiries about your credit score as many times as you wish and it will not affect your scores. There are some free resources that allow you to follow the changes in your credit history and credit scores (see below). However, there is a so-called “hard inquiry” – it’s when your potential lender sends an inquiry for your credit score, that means you apply for a new loan. In this case, your scores could be decreased.
Myth: Only paid loans count for credit scores.
Truth: In fact, everything, that relates to mandatory payments count: Insurance premiums, utility bills, loan installments, taxes and so on. Each negative issue is immediately reflected in your scores.
How to track your credit score improvement?
There is no need to pay for getting your credit report and credit scores. There are some great web resources people use to track such data:
This is a totally free resource that provides an access to credit report for anyone (no credit card needed). The website delivers reports from TransUnion and Equifax with a weekly update.
It’s a free credit checking website that is available for anyone who wants to monitor changes in credit reports. Information updates once a month and is delivered to a user with loan offers (additional option on demand).
This is another, a less known, yet great resource, that gives an access to credit reports to borrowers and lenders.