Credit rating is a subject grossly misconstrued by many consumers, and it’s largely due to the lack of education provided to young people regarding what credit is, how it’s used, and why it matters. It’s not a subject discussed in the average high school classroom, and many people miss the opportunity to teach their children the importance of healthy finances and financial living.
As a result, some people end up making mistakes with their finances that affect their credit, and learning about credit is NOT best when it’s done the hard way. When it comes to credit history, credit scores, credit rating, and loan applications, there are many things that the average consumer doesn’t even realize are important.
What is a credit score? –
Investopedia says that a credit score is “a statistical number that depicts a person’s creditworthiness. Lenders use a credit score to evaluate the probability that a person repays his debts. A credit score is a three-digit number ranging from 300 to 850, with 850 as the highest score that a borrower can achieve. The higher the score, the more financially trustworthy a person is considered to be.”
So what are some of the things that make up a credit score? While FICO is smart to not release any proprietary information on how they calculate a credit score, they do give us a little insight into how it’s done:
- Length of Credit Use: Credit history
- Payment History: On-time payment history
- Credit Usage: The amount of credit a person has
- Amounts Owed: The amount of credit a person uses
- Types of Credit: The type of credit a person has
- New Credit: The pursuit of new credit
Credit bureaus take a long look at a person’s financial usage to determine a feasible score that reflects how much of a risk they are for lenders. This number is based largely on how responsible a person is with their credit, and a higher credit score indicates a lower risk.
What is credit rating? –
Credit rating is the chart used to determine how good or bad a person’s score is. The problem is every credit bureau uses a different chart to determine what constitutes as a good and/or poor score. One bureau might decide someone with a 720 credit doesn’t sit high enough on their credit rating system to have excellent credit, but another company might decide this is an excellent score. It all depends on the credit rating model or chart they are using.
Credit and Loans –
When it’s time to fill out a loan application, lenders look at the credit score, credit rating, and other information. Some bad information passed down from person to person is that lenders only look at a score to determine whether they want to work with a person. Some banks and lenders look at the score, but they also look at a few additional pieces of information. A credit union, for instance, might look at a low score compared to the length of time it’s been since someone made a late payment, missed a payment, or wasn’t employed to determine risk. This kind of lender knows things change, but scores don’t change so much in such a short time.
Loan applications want a variety of information, and many companies are even willing to work with people who have low credit scores and imperfect credit ratings. When people fill out loan applications, they provide their personal information and their credit history. This could affect the overall number of their score. The inquiry sent into the credit bureaus by people who want to apply for loans or other financial means can cause scores to drop.
When consumers apply for multiple credit cards, loan applications, and other financial needs, their score drops significantly if it’s all done in a short time. Lenders don’t want to see people applying for a lot of credit at once. It implies a certain standard of neediness that makes them nervous and it makes the person a higher risk.
Before applying for a loan, increase your credit score
You should consider your credit score or credit rating before you ever apply for a mortgage or a car loan. The credit score – also called a FICO score – describes your ability to carry and pay your debts. If you want to purchase a home (mortgage loan) or car (auto loan), but are concerned that your FICO score might be too low, you should follow these tips to help raise it before you apply for any type of loan:
1. Have your credit rating pulled –
According to the United States Federal Trade Commission (FTC), you are entitled to one free credit report each from Equifax, Experian, and TransUnion. After providing your basic information, including your name, address, and Social Security number, you will receive three slightly different snapshots of your credit picture from these companies.
2. Clean up errors –
If there are mistakes on your credit score – and mistakes can easily be made – you can write to or call the reporting agency in error. Be prepared to back up your claims of error with documents or articles that support your testimony. When they are corrected it will be worth the time to improve your credit rating.
3. Avoid bankruptcy –
If you want a pristine credit score, the last thing you should do is declare bankruptcy. The reason is simple: this action will subtract hundreds of points from your credit score. Bankruptcies aren’t short-lived, either. They can stay on your credit report for up to 10 years.
4. Formulate a plan to pay off your debts –
If you are carrying a great amount of debt, it could have a negative impact on your FICO credit score. One way to raise the score is to formulate a plan to pay off your debts. If you aren’t sure where to begin, seek a credit counseling session. Advantage CCS offers free in-house and online credit counseling services.
5. Pay your utility bills on time –
This often-overlooked step can make all the difference in the health of your credit score. Late or missed utility bill payments will lower your credit score fairly quickly. If you are having difficulty paying these bills on time, you might be able to negotiate payment plans with your utility providers. You might also be eligible for the Low-Income Home Energy Assistance Program also known as LIHEAP.
Credit and loan applications are confusing to many consumers, but knowing how applying for loans affects their credit, their finances, and their interest rates can help make it a little more understandable. Knowledge is power, and financial knowledge is the key to a future filled with financial freedom and less stress. If you need help figuring out your credit score or for more ways on how to improve it, give us a call at 866-699-2227 and speak to one of our certified credit counselors for free.