How Credit Rating Works

Written by admin, last updated March 19, 2019

Credit cards, loans, and mortgages are now part of everyday life. Even so, not a lot of people know how credit rating works, which is why there are individuals who become surprised at finding out that their loans are not approved due to bad credit. This article discusses just about everything that you need to know about how credit rating works.

How credit rating works

Your credit rating (also called credit score) is the number that tells creditors whether you're actually someone who has credit worthiness, that is, the individuals who are worth lending money to. In truth, there are several systems that are used to determine what your credit rating is, but the one that's most popularly used (and essentially serves as the backbone in how credit rating works) is the Fair, Isaac, & Co. (FICO) score, used by the biggest credit bureau in the world.

The FICO score (or other system used to determine credit scores) form the core of how credit rating works. Credit bureaus receive information from your creditors about your credit history. From there, they will then use the FICO store to determine what your credit score is based on said history. The FICO score is a number between 300 and 850. This number informs creditors just how high a risk of a debtor you will be should they grant your loans. The higher the score you have, the more likely will your creditors extend credit, as this means that you make timely payments and there are no smudges in your record that indicate that you're a risky borrower. On the other hand, if you have low credit scores, this means that you're a high-risk borrower. This essentially serves as a red flag to a lot of creditors and loan agencies, and they sometimes use your bad credit history to deny your application. It's important to note that bankruptcies, foreclosures, and liens can set you back by as much as 100 points in the scoring system, which is why these should only be done as a last resort in managing your financial concerns. Do note that your credit history is primarily based on what your creditors report to the credit bureaus. As such, your late payments may not affect your credit history if your lender doesn't actually report it to the agency.

Interestingly enough, only 13{8e6cf663dd8bbfda1f4fdd38af84969e57c1756d87f56947f5c326d1d8b26fdc} of the American population has a credit rating higher than 800. The majority of the population has a credit score between 750 and 799, while 15{8e6cf663dd8bbfda1f4fdd38af84969e57c1756d87f56947f5c326d1d8b26fdc} of Americans have a credit score lower than 599.

While not included in how credit rating works, your credit history may also contain personal information, such as your address, income, savings, and employment history. While credit bureaus do not give people their exact credit rating, it is possible for lenders to get a free credit check in order to have a general idea on where they stand with their creditors.

Commonly misunderstood concepts about credit score

In the same way that not a lot of people know how credit rating works, there are also a large number of the population that have a wrong concept about the factors involving their credit rating.

The biggest mistake people make is in believing that credit bureaus are actually infallible. This is certainly not the case, which is why a lot of people have successfully overturned their bad credit because of the inaccuracy in their records.

Another mistake that people make is assuming that credit scores reflect their ability in making payments. In truth, credit ratings are less concerned about your actual ability to make payments but are more concerned about how high a risk you pose in not paying your loan. As such, even if you have a steady source of income and have high savings, it's possible for you to have your loan denied or be labeled as a credit risk if you don't pay your credit card bills on time.

Yet another misconception people make about credit rating is the fact that they assume that your age actually plays a role on what your credit scores are. This isn't actually true, although admittedly, you will have a healthier score if you're older, if only because of the fact that you have made more loans in your 40s than when you were younger. In short, what matters isn't your age, but the length of time you've maintained your score.

One important thing to know about credit ratings, again, is the fact that it's possible for creditors and lenders to use different rating systems in determining what your credit history is. As such, a loan company that uses the FICO system may approve your loan, while another company that uses another scoring system may reject your application because you look to be a risky borrower using that system.

Finding out how credit rating works is an important part of managing your finances. By knowing how the system works, you will be able to accurately make decisions regarding your financial situation in order to maintain a good credit history.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram