We live in a credit-driven world, where our credit scores affect or determine the many aspects of our everyday lives. But what is a credit score? And what is it for?
First, what is credit?
Your credit is based on your borrowing history and is taken from the information in your credit reports. It tells people about your ability to borrow money and the amount of money you have borrowed in previous transactions. It lets them know how likely you are to pay off your loans and tells lenders whether they should approve your loan requests.
Credit score explained
Credit reports contain your history as a borrower. They’re made up of many pages of information on your previous loans, financial transactions, and other important information. Because it won’t be possible for bank employees and lenders to go through every line of a loan applicant’s credit report, they rely instead on a credit score.
A credit score is an assessment of your creditworthiness. It is generated by a computer program and is based on your credit history. The program evaluates your credit reports, looks for red flags and patterns in your financial transactions and produces a credit score.
Credit scores range from 300 to 850. Lenders use your credit score to predict if you will be able to repay your debts.
If, for instance, your credit score is above 720, you may be deemed financially trustworthy and your loan could be approved at once. If it is between 650 and 720, you may receive a higher interest rate and end up paying more money in interest throughout the loan.
If your credit score is lower than 650, you may be considered a subprime borrower and your loan application may be denied. People with credit scores below 650 are usually required a shorter repayment term. Or the lender may require their loans to be co-signed.
The purposes of a credit score
While we often hear people complaining about their credit score, this seemingly random number actually affords advantages for both borrowers and lenders.
First, credit scores allow lenders to automate their lending decisions, which saves them money. This makes borrowing money less expensive.
Credit scoring also makes the process of lending fairer. Because lenders use credit scores to determine the financial trustworthiness of an applicant, it eliminates the possibility of being discriminated on based on your race, age, nationality, or other traits.
For lenders, credit scoring offers a level of protection against borrowers that are likely to default on their loans. This helps reduce the company’s losses.
Aside from being instrumental in making lending decisions, credit scores are used in many other industries that impact your life. For instance, if you want to rent a house or an apartment, the landlord may ask to check your credit. A good credit score may score you a new home while a bad credit score may lead to a higher deposit and may even keep you from being able to rent.
When you apply for services like water or electricity, the utility company may pull your credit. If you don’t have a good credit score, they may require a larger security deposit.
Insurance companies check your credit score to see if they should cover you or not. They also use it to determine the rate that they should charge you.
Your credit score may also play a big role in the job application process. Depending on where you live, prospective employers may check your credit score and use it to judge your trustworthiness and sense of responsibility. However, employers must first seek your authorization before they pull your credit score.
These are just a few of the ways in which a good or bad credit score can make or break you. If you want to learn more about credit scores in hopes of improving yours, we recommend looking over scholarly articles, essays, and reports on the topic for example you can read this credit card essay that we hope will be useful for you. Good luck!