Credit card companies, banks and other lending agencies play the risk game when it comes to loaning out money. To increase their chances of making a profit, they first examine the credit rating of each borrower prior to assigning interest rates and approving loans. That way, lenders can predict the likelihood of potential borrowers repaying their debts with interest in the future. A higher credit rating can earn you a good loan, while a bad one can possibly get you rejected.
History
The credit rating system, developed by the Fair Isaac Corporation in 1958, increased in popularity throughout the 1960s and '70s. Banks learned to rely on it for predicting the credit worthiness of borrowers; that is, the probability of them repaying loans. As of 2010, lenders can request a credit report by phone or Internet, knowing within minutes how deserving you are of credit.
Credit Report
A credit report details your history of credit spending and repaying. Three leading bureaus have databases built from various creditors and loan granters that lenders turn to for your credit history. About every month, these credit reporting agencies receive new information on your remaining balances and debts, which they use to compute your credit rating.
Credit Score
A credit score is a calculation of your credit rating according to updated algorithms initiated by Fair Isaac and Company, or FICO. Each credit bureau has its own methods of reporting your credit score, either using FICO score or VantageScore standards, but lenders treat both methods of determination equally. Scores in the FICO system vary from 300 to 850, with values higher than 750 indicating good credit ratings, while the VantageScore system varies from 501 to 990 points, with higher brackets such as 801 to 900 and 901 to 990 reflecting good credit ratings of grade B and A, respectively.
Improving Your Credit Rating
According to a January 6, 2009, article in the "New York Times," there are several ways in which you can improve your credit rating. First of all, setup automatic payments on all of your accounts. Missing a payment or paying late can severely lessen your credit score for up to 7 years. Secondly, keep your total debt to a maximum of 7 percent of your credit line. For instance, if of four credit cards, your cumulative max limit is $6,000, then do not keep an outstanding balance of more than $420 (6,000 x 0.07).
These two factors alone account for 65 percent of your credit rating. The remaining 35 percent is based on the average length of your credit history, the number of inquiries to your credit report and the types of credit you have. For instance, you can improve your score by not opening new accounts, which lessens your average credit history length. Also, resist applying for new credit cards when you do not need them. Each application results in a credit check, lowering your score. Lastly, credit cards have greater impact on your credit score than mortgages, but mortgages better reflect your responsibility with long-term debt.
Benefits of High Credit Ratings
Having a FICO score of 750 or higher can provide you with numerous benefits, according to a recent April 2009 "Newsweek" article. In fact, credit card companies aim to serve borrowers with higher credit ratings because these users are more likely to pay off their balances in full and on time. To entice them, creditors will offer lower APRs, or annual percentage rates, on loans and better benefits on credit card purchases. Improving your credit rating is something worth investing in. Even paying off a few debts can improve your score in a matter of months.
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