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What is Actually a Credit Score?

By Ruth Racey
Published: Sunday, September 20th, 2009

Those planning to take out a loan have to know what a credit score means. They may think that it is simply the points that one earns when purchasing goods using a credit card. Credit scores are more than that. In fact it is complicated and requires more than a passing study.

Credit cards are considered in calculating a credit score. However, a lot of other things are also considered. There are the kinds of loans you have taken in the past and present, as well as your payment record, whether you are a good or indifferent borrower. All information about an individual’s credit history is analyzed to come up with an accurate credit score.

How do credit companies collect data on a person’s credit history? It is quite simple. All they have to do is to ask credit bureaus, since they obtain the information from lending institutions and compiles them into huge databases. Credit records of just about everybody who has taken up a loan will be available at the bureaus.

Credit scores are extensively used by lending firms like banks to measure the creditworthiness of loan applicants. A score below 700 is not good. The bank, however, will probably offer a lower loan amount at a higher rate of interest and shorter payment period. These loan terms pressure borrowers to pay loans immediately since carrying it too long will be a great burden to their balance sheets.

The lender’s decision to approve a loan is largely influenced by the score of the borrower. Naturally they would like to lend money to as many people as possible, but they must be certain that majority of the loans get paid. With credit scores, lenders are able to identify who among the loan applicants are potential good borrowers.

Assessing who to lend money to is the main purpose of a credit score. The usual question it tries to answer is how well a borrower manages money, especially borrowed money. If an applicant has good reputation among lenders as a person who pays on time, then certainly he gets a high score and likely to get a loan approved. In contrast, those who are habitually in debt, earns less than their debts, and has a history of payment defaults, get poor credit rating and lesser chance of getting a loan.

The standard model for computing credit scores is the model developed by Fair Isaac Corporation or FICO. Equifax one of the three credit reporting bureaus uses this model while the other two bureaus have their own. Equifax sells credit scores through their website for 12.95 USD while the other two sells their own at a slightly lower price.

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