Lenders, such as banks, use your credit score as the major gage to determine whether they should approve you for a loan, set the interest rate and terms. They will go through your credit history, your ability to pay on time, your income, industry, what lines of credit you currently have, your debt ratio and they will make a risk assessment if you can qualify for a loan and how much. A high credit score will show lenders that you are willing and able to pay your loans on time and in full. This is why maintaining a high credit score is a must when applying for any kind of loan. In this article, we will discuss in more details what and how exactly lenders and banks look at your credit score.
The Credit Score Methods Banks and Lenders Refer To
There are two main credit scoring methods FICO® and VantageScore®, but the most common method lenders refer to is the FICO® method. You have different FICO® scores for each of the 3 major credit reporting agencies which are Experian, Equifax, and TransUnion.
FICO® scores will range from 300-850, the higher the better. Your credit score will likely vary from each of the credit agencies. Here are FICO® score ranges and their respective ratings.
- 300-579 – Very Poor – credit applicants with these credit scores have a high chance of not being approved at all.
- 580-669 – Fair – credit applicants with these scores are below average but a lot of lenders will still approve loans.
- 670-739 – Good – credit applicants with these scores are considered to be near or above average borrowers.
- 740-799 – Very Good – credit applicants with scores in these ranges are dependable borrowers and are more likely to receive above-average rates from lenders.
- 800-850 – Exceptional – credit applicants with scores in these ranges are exceptional borrowers and have the highest chance of getting the best rates from lenders.
The majority of lenders will use FICO® scores from all three credit reporting agencies when assessing your loan application. Having a lower credit score will still negatively affect you even if you acquire the loan because of the higher interest rates.
A difference between a credit score of 630 and 770 can be thousands of dollars each month. A lot of lenders especially in the mortgage industry have strict FICO® credit score minimums in place. A point below this threshold can result in a rejected application.
The Components of your FICO® Credit Score.
As the FICO® credit score is the most common score referred to by lenders, it is important to know and understand its various components. Listed below are a bunch of major components that form your FICO® credit score and how much overall effect each component has on the score.
- Payment History: 35% – history of missed payments such as bills and rent and defaulted loans.
- Current Debt: 30% – existing debt and total owed, type of loans you currently have, how many credit cards are maxed out, etc.
- Credit History Length: 15% – are you new to credit or a longtime borrower?
- Credit Inquiries: 10% – recent applications of numerous loans
- Types of Credit: 10% – how varied your types of debt are; auto, student, home loans, etc.
As you can see, Payment History and Current Debt play a huge role in how your credit score looks. You must do well in these areas to maintain a high score. The credit recording agencies keep records of late payments for up to 7 years.
The length of your credit history also has a role, but not as much. Credit scoring systems require at least 6 months of credit history to properly calculate a credit score. You may have a “thin credit file” if you don’t have a long enough credit history.
You can build up your credit history by opening a secured credit card and using it responsibly to demonstrate that you can manage credit properly.
Other Major Factors Banks and Lenders look at.
Your Credit score is a major factor when lenders evaluate your loan application but it alone will not guarantee that your loan application will be granted. Here are equally important factors that lenders look at when assessing your loan application.
- Credit Reports
Your credit score is calculated based on the data in your credit reports. These reports are each compiled by the three major credit reporting agencies separately: Experian, Equifax, and TransUnion. They get your credit information from various sources such as lenders. Lenders can also pull your credit report to assess your creditworthiness. They will check how clean your financial records are, lenders like to see minimal to zero missed payments. They will also check for bankruptcies, delinquent accounts, any outstanding debts, foreclosures, etc. Practicing proper financing will lead to better credit reports which in turn leads to higher credit scores.
Be advised that there may be errors in your credit reports from one credit reporting agency that does not appear in another. Addressing these errors before starting a loan can save a lot of headaches in the long run. If you need assistance in this matter you can consult a financial education company such as Credit Star Funding.
- Monthly Income and Expenses
Having a stable income and few unnecessary expenses can make lenders view you as less of a risk because they will have peace of mind that you can pay your debts every month. Lenders also assess additional income from investments.
Lenders will calculate your debt-to-income ratio (DTI) which compares your total income and total recurring debt every month. To calculate your DTI, you can divide your recurring debts like mortgages and credit card payments by your gross monthly income without taxes, expenses, etc. Most lenders prefer DTI ratios below 36%.
- Liquid Assets
Some lenders might ask if you have any assets such as stocks, tax refunds, government funds, etc. that can be converted into cash in a short amount of time. If you do, the lender may view you as less risky because you have ways to pay your debts in case of an unfortunate event such as losing your job or health concerns.
- The Length of the Loan
In general, lenders will assume that shorter loan terms mean the borrower’s ability to pay is not going to change during the loan. Keep this in mind when applying for loans.
- Your Employment History
The lender may choose to review your employment history in the past year or two when applying for a mortgage, in which he will measure your income stability. Having an inconsistent and spotty work history will not get you rejected but the lender might charge higher interest rates.
- Collateral
The lender will carefully inspect the value of the vehicle or home when applying for an auto loan or mortgage. These can act as collateral for the loan just in case an unfortunate situation presents itself and you default on your loan. The lender will then sell your house or vehicle to compensate for the expenses.
Ways to Improve a Low Credit Score and Maintain a High Score
We have outlined the factors banks and lenders look for when evaluating your loan application and stated the consequences of poor credit score and credit history. But what can we do to improve an undesirable credit score or maintain a high one? Here are some ways you can do that:
- Paying all your bills on time on the agreed date every month will greatly help your credit score. Use tools such as automatic payments or mark calendar dates to help remember to pay on time every month.
- Pay payments that are behind as soon as possible because late or missed payments’ impact on your credit score will decline over time.
- Keeping balances on credit cards low and avoid maxing out your credit cards.
- Avoid opening new credit cards frequently as this creates hard inquiries in your credit report and these hard inquiries can negatively affect your credit score. Space your credit account openings a few months apart.
- Make sure to dispute accuracies on your credit reports when you discover them. Inaccurate information can drag your credit score down.
- Make sure to acquire copies of your credit reports to track your progress. You can get free copies from each of the credit reporting agencies every 12 months.
- Keep your credit utilization low when using credit cards. Your credit utilization is the percentage of your credit limit you use. It is advisable to keep credit utilization below 30%.
- Keep old credits accounts open because closing one will affect your credit length history as it counts the average age of all accounts from oldest to newest. Which in turn affects your credit score.
If you have credit problems call us today at 800-637-0795
http://creditstarfunding.com
