Almost everyone has to borrow money at one time or another. Whether you are borrowing to finance a business, or to buy a house, car or some other major purchase, good credit worthiness makes a vital difference as to whether or not the loan is going to be granted and on what terms.
A lender must estimate the level of risk by reviewing your record for handling loans and their repayment obligations, and assessing your current financial situation. Besides individuals seeking loans, being a good credit risk is also highly relevant to corporations and local authorities, and even to nations — just as individuals with a history of loan defaults are going to be considered high risk borrowers, countries with unstable governments and fragile economies also become classified as bad risks and this makes it difficult for them to borrow on the international markets.
How Your Creditworthiness is Determined
A key ingredient in credit worthiness calculations are the credit ratings calculated by the three major American credit bureaus: Experian, TransUnion, and Equifax. These bureaus compile reports on individual credit status based on details such as payments history, the range of credit options used, the length credit accounts are active, the amount of activity, and credit debts accumulated. The report also includes any legal actions, court judgments or tax liens relating to that person’s finances. The credit bureaus collect this data from banks, credit card companies, and finance companies amongst other sources. As long as you have had one credit account open for more than six months and it has been active in the past six months there is going to be enough data to compile a report.
Individuals receive a three digit FICO score based on their credit reports and the FICO scores for all these three bureaus are of interest to potential lenders. The score can range between 300 for those with the most problematic credit records to 850 for a top credit rating. It is important to point out that in addition to influencing bank lending decisions FICO scores are also checked by insurance companies and they can affect eligibility for certain jobs. The term FICO comes from the name of the company, Fair Isaac, who developed this particular credit rating methodology.
Although FICO scores are widely used in the USA to determine credit worthiness, they are far from the sole determinant of whether or not the requested loan is going to be granted. First of all there are other credit bureaus that devise credit scores based on different methodologies. Furthermore, lenders are certain to investigate aspects of the potential borrower’s financial situation that are not covered in credit reports. In particular lenders want to know about the borrower’s income and employment history, and each lending institution has their own criterion for determining loan eligibility and the generosity of terms the borrower may be offered.
Gains from Maintaining a Good Credit Rating
In today’s tough economic climate maintaining a high paying job is often outside the employee’s control but with a little forethought and willpower credit ratings can be protected. Paying bills on time and avoiding getting into debt to the point you can no longer meet loan repayments should be sacrosanct principles in handling your financial affairs. A look at the difference in the loan terms offered to people with high and low credit scores should be sufficient motivation. For example, suppose you have a FICO score of under 639 and want to take out a $70,000 thirty years fixed loan. You could expect at current rates to pay an APR of 6.222 % which translates into monthly payments of $430 and the total interest you are going to pay would be $84,702. With a high FICO score of over 760, the APR falls dramatically to 4.633 % and this translates into monthly payments of $360 with the total interest paid eventually equaling $59,684.
Keeping Track of Credit Scores
It makes sense to exercise your right to get a free copy of your credit report from the three major credit bureaus each year, and this right is independent of whether or not you have been denied credit. With all the efforts they put into producing accurate reports, due to the amount of data handled the possibilities of confusing people with similar names or social security numbers and a myriad of other variables means there is always the possibility of error. It pays to check the report carefully to verify that all the details are accurate. If a decision to deny credit is based on your credit report, the lender has to notify you from which bureau they received the report and you have two months to request a free copy.
Although credit history stays on the reports for seven years and in the event of a personal bankruptcy for ten years, the negative impression and score resulting from irresponsible actions and business setbacks can be erased if subsequent actions show responsibility and financial stability.