How Does A Credit Rating Work?

Your credit history and credit rating are particularly important if you are planning to apply for credit. Credit includes loans, mortgages, credit cards, store credit and lines of credit. Each credit creditor determines the type of credit and the minimum credit rating they require you to have based on different factors.

Your credit rating reflects the information reported to the credit bureaus by your financial institutions and the creditors you have had dealings with. This information can mean the difference between being approved for a credit card with an interest rate of 15 per cent or one with an interest rate of 24 per cent. A good credit report also means that you are more likely to be approved for lower-cost mortgages and to be able to buy a house quicker.

But How Does a Credit Rating Work and What Are the Factors Used to Calculate It?

When you apply for credit and it is approved, the information is provided to a credit bureau. There are 3 major credit bureaus – Experian, TransUnion and Equifax. These credit bureaus then collect information on how you pay your credit every month and other factors that may affect your personal risk profile. They then use this information to establish a credit history from which they calculate a credit score or rating.

Equifax expects a score of at least a 720 to be considered ‘good’. This information is then passed onto the various credit agencies who then decide what score to give you. For the most part, the higher your score the lower your rates. However, every lender sets its own minimum score requirements. For example, a score of 720 may be considered ‘very good’ for a car loan but only ‘fair’ for a mortgage loan.

To make things more confusing, some lenders will offer preferential rates to people not in arrears or on serious credit watch. In other words, a score of 640 with no arrears or defaults may be acceptable for some people while 720 may not be good enough for others.

A credit score is one variable used to calculate your credit score. Credit reports also include information on the number of inquiries you have made, the amounts of debt you have carried over a period; how long your credit lines have been active; how you have made payments; and whether or not you qualify for landlord and tenant reports. Credit bureaus also keep details on bankruptcies, civil judgments, defaults and liens.

Credit scores are then used by creditors to predict the risk of defaulting on their financial obligations.

The following factors are taken into account when determining your credit rating:

– Paying your creditors on time and in full when a repayment is due improves your credit rating. However, if you miss payments or consistently pay late, then your credit rating will be negatively affected.

– A judgment against your name for non-payment of debt or a blacklisting will also reflect badly on your credit rating.

– If you have accumulated too much debt. This may mean that you cannot afford to repay new debt.

– If you have no debt or insufficient credit to calculate a credit score from your credit history.

– How often you make an application for credit and whether this credit was approved or not.

– The length of an established credit history.

Every bank, finance company and lender uses an entirely different formula to calculate your credit score; and it is safely understood that there is no such thing as the perfect credit score. However, there are certain factors that creditors like to see. The more of these factors you have, the better your credit rating will be.

Conclusion:

Upgrading your credit score is all about proving to your creditors and to the credit bureau that you can manage your finances better (e.g. use credit responsibly). Rebuild his credit quickly through an organized action plan utilizing the thought leadership, advice and strategies provided here.