By Srijan Sen
In the United States, a score allocated to every individual based on a credit history calculates financial worth.
In order to secure a house mortgage, car loan, or apply for a credit card or even a cellphone contract, one must have a satisfactory credit score. Individual credit scores play an important role in calculating financial risk for the lending organization.
A credit score is a statistical method to determine the likelihood of an individual paying back the money he or she has borrowed. FICO, acronym for the Fair Isaacs Corporation, is the creator of the software used to calculate credit scores.
Various credit organizations use this software and different evaluation criteria based on a number of variables.
Primary variables used to calculate an individual’s credit score include: previous credit performance, current level of indebtedness, time credit has been in use, types of credit available, and pursuit of new credit. Since various aspects are in play and weighted differently, three major U.S institutions – Equifax, TransUnion, and Experian – may issue different credit scores even though the information remains the same. Typically, scores range between 350 (poor score) and 850 (very good score).
In addition to the FICO credit scores, the U.S credit market uses a scale of 0-9 to rate personal credit.
On this scale, each number is preceded by one of two letters: “I” signifies installment credit (like home or auto financing), and “R” stands for revolving credit (such as a credit card). A lower number represents a better credit history.
When an individual borrows money, the credit organization sends information to credit bureaus indicating how efficiently the borrower handled debt payments in the past.
A credit rating is highly affected by the propensity for paying off debt. Hence, payments made on time guarantee a good credit score.
A credit report makes it possible for stores to accept checks, for banks to issue credit or debit cards, and corporations to manage their operations. According to financial theory, increased credit risk means that a risk premium must be added to the price at which money is borrowed. It means a bad credit score will not disqualify an individual from gaining access to credit options, instead the rate of interest will be significantly high compared to someone with a better credit score.
According to Investopedia – a website serving as a resource for investing education, personal finance, market analysis and free trading simulators – the following are some of the steps that can be taken to maintain a good score and rectify a bad one.
• Meet your payment deadlines.
• Keep from straining your credit. Do not use credit cards sent to you by mail.
• Never ignore overdue bills. When you run into problems paying a bill, address it by calling the company you owe too. They’re likely to be flexible if you let them know early.
• Know your credit score at all times. And understand that financing companies have a negative influence on your score.
• Pay your debts off as early as possible. Longstanding debts negatively affect your score.
• Don’t apply for credit cards or other loans frequently. Each time someone looks at your score, it could slightly harm your credit.
• Long credit histories are looked on favorably. Although the exact formulas used to calculate credit scores is still a mystery, FICO has disclosed an approximate breakdown of what comprises a credit score and how much weight they carry.
• Timeliness of payments = 35%
• The amount of revolving debt in relation to the amount of your total revolving credit = 30%
• Length of credit history = 15%
• Type of credit used (installment, revolving, consumer finance) = 10%
• Amount of credit recently obtained and recent searches for credit = 10%
The importance of a credit score is significant to every resident of the nation. Ignoring individual credit history can have detrimental effects on a person’s financial health and future of obtaining credit.