What is Actually A Credit Score?

Those who had never before approached a lending institution for a loan may not be familiar with what is actually meant by a credit score. They might infer it as a system of points that you score with purchases of goods and services through credit cards. But a credit score embraces something more complex as we will soon see.

Credit Score Calculation

A credit score does take credit cards also into account, but it takes many more things as well into account such as all types of loans and repayments, late payments, missed payments, and in fact every aspect of credit formation and management that comes within the area of credit related operations of any individual. A credit history is a numerical representation of your entire credit history comprising of loans taken together with their other related particulars from perhaps an individual’s college loans up to his most recent credit card.

These particulars are obtained from registered lending institutions by three accredited credit reporting agencies, also called credit bureaus who feed them into their vast databases so that practically everybody’s credit record becomes available with them.

Lending Institutions including Banks use credit scores on a large scale to assess the creditworthiness of their prospective customers who come for loans. With a credit score below 700 that is considered not good, a potential borrower’s chances of getting the loan approved are rather slim. However, he could be offered something much less than the amount he applied for to be paid back at a higher rate of interest during a shorter period. Lenders are aware that some people will try to finish their loans quickly, only if the interest was set very high as to make it virtually unprofitable for them to drag the loan.

The ultimate decision of a lender as to whom to lend and subject to what terms and conditions is influenced not only just to a great degree; but I would say entirely, by the power wielded by the credit score. Although the lenders stand to earn more income by way of interest charges by lending to as many applicants as possible, they have to exercise caution to ensure that the money is lent to a person who knows how to manage it, or else, instead of earning income, they stand to lose their capital too by putting their money in the wrong hands.

A credit score reveals a lot about a prospective borrower. Do you carry some reputation and respect with lenders as a person who knows how to manage credit? Are you habitually late in effecting payments? Are you for most of the time sunk deep in debt? Are you also one of those types whose only incentive for making any payments is a very high rate of interest? You need not answer the truth to the last two questions; your credit score will. They are definitely not hallmarks of good borrowers.

On the other hand, do you handle credit cards any better? Have you maximized your credit creation by taking as many credit cards as possible and utilizing each to its maximum limit? Do you always pay only the minimum amount at the end of every month or do you try to settle the bills on a first in first out basis? What are your other debts in terms of types of credit, the number of unpaid loans and the total outstanding debt? Are you constantly having problems over settlement of loans? Again, I was actually not asking you. Its all there in your credit record for everybody to see!

A lender will see if the amount of loan you have to pay monthly on average according to your present total debt as at date is compatible with your income, or in other words, what percentage of your income goes for debt servicing. If your credit score reveals poor income too in addition to your unmethodical handing of finance and credit, then he has all the reasons to refuse your loan application.

Fair Isaac Credit Score

Credit scores are computed using the standard model devised by Fair Isaac Corporation popularly known as FICO. It is the most widely used method for credit score computations while some credit bureaus use their own models, the end results of which are seen to be favorably comparable.

The credit bureau also called credit reporting agency, Equifax supplies their FICO credit scores via their website at a cost of $ 12.95 each while the two other credit reporting agencies, namely Experian and TransUnion sell their own versions of credit scores for a little less. 

It is hoped that the above discussion would have given you more insight into what a credit score actually is and what it is capable of achieving.