Imagine that you need a loan to buy, say a car. What do you do? Simple, approach a lender. The lender will basically go through some very important documents, namely, your credit report, credit score, credit history and credit ratings. The credit report contains all sensitivity information such as your total debts, income and your record as a borrower. The credit history is a record of all your repayment records. Mind you, the lender first views, the late payments and the defaults when he lays his hand on the credit history. Lenders then consider the credit ratings which are alpha numeric figures that indicate the time period within which the borrower will be able to repay a particular loan. This figure is basically derived on the basis of the credit history and factor such as income and current debt to income ratio. For example, a R1/I1 rating means that the borrower will be able to repay the said amount in 1 month. The alphabets are basically the codes for types of credits and loans, such as R for revolving credit, M for a mortgage loans, A for an auto loans. The credit score is basically calculated on the basis of all these factors. Thus, the better your report, history and rating, the better is your score going to be. The credit score unlike the credit ratings is a single numerical figure and a total of almost all credit reporting aspects.
How is a Credit Score Calculated?
The credit score that is analyzed by your lender is usually derived from a mathematical model, that is provided by Fair Issac Credit Organization (FICO). The FICO provides several different mathematical models to credit reporting agencies and Bureaus. In United States of America, the three giant credit rating organizations, namely Experian, Equifax and TransUnion, cater to the people's and lender's need for credit reports and score. The drawback of such a situation is that every agency uses, a different system to churn out scorecards and eventually supply credit reports. Hence, there are at least 3 different credit scores of a single person. Experian uses Experian-Fair Isaac Risk Model, as a means for calculation of credit score, Equifax uses Beacon and TransUnion uses FICO Risk Score - Classic Model.
The end result is, there are 3 different scores (which numerically speaking are not very different) and reports that a lender on an average will have to refer to.
What is a Poor Credit Score?
The concept of the mathematical models that have been developed by FICO, are fast gaining importance in the lending sector. The credit score figure is the most important element of the credit report. The credit score which has been calculated on the basis of FICO formulas, ranges from 850 to 300, the best being 850 and worst being, 300. There are also very, very rare instances where people have credit scores that are below, 300. In such situation, the person usually does not have any credit history.
A credit score that ranges from about 580 to 600 (+/- 20) is considered poor. This score is not exactly horrible but is definitely making your credit report fat with unhealthy entries. This credit score means that you will have to pay a large amount of interest, premium and not to mention, a commission to the lenders. For example if you are planning to apply for a fixed mortgage that is spanning 30 years, you will have to pay an interest at the rate of about 8%, which to be frank is quite substantial. Instead, if we look at the bright side, it is evident that this score is easy to improve. You can take the help of mortgage or loan for as many of them have favorable terms and conditions. In case if you have a large number of debts, you may also refinance with loans. The crucial part comes after the loans have been sanctioned to you. In such a situation, you will need to plan out some really good repayment strategies. In fact, I would recommend you to take up loans that fit into your debt to income ratio. Due to this you will be able to repay your loans comfortably.
It must be noted that even if you have a bad credit, reaping a loan on time, will help you improve you credit score. A better credit score will help you in fetching favorable terms and conditions and lower rates of interest.
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