As economic situations hinder the American income, many individuals turn to credit cards as means of buying now what they can potentially pay for later. However, before borrowers can take money from lenders such as credit card agencies and banks, they have to prove their credit worthiness with a history of responsible spending and repaying. This history determines a credit rating that decides the likelihood borrowers will be approved for credit, as well as their annual rates.
History
The credit rating system started in 1958 to keep track of which borrowers were not repaying on their deals. Over time, more lenders adopted the practice created by the Fair Isaac Corporation (FICO) to ensure better profits on their loans. As of 2009, the credit rating system serves over 80 countries across the globe.
Credit Reporting
Each month, creditors and granters report the payment history of borrowers to different credit reporting agencies like TransUnion, Experian and Equifax. These agencies store the information in their databases for use in updated variations of the original Fair Isaac calculations of credit. Whenever a lender wants to know whether or not you have good credit, they contact a credit reporting agency for your score and analyze your credit report to determine the value of your credit rating.
Credit Scoring
The most common index of credit rating is your FICO score. It rates users on a 300- to 850-point scale, where 40 percent of users fall in the 750 to 850 range of "good" credit. However, a newer scoring system developed by the credit bureaus called VantageScore rates users on a 501- to 990-point scale, where grading school letters, A through F, represent your credit rating for every 100 points on the scale. Although FICO scores may be lower than VantageScores, the computations remain nearly the same, and lenders do not interpret the two differently.
Credit Rating Factors
Your credit rating depends mostly on your payment history and debt. According to a January 2009 "New York Times" article on credit scores, whether or not you pay bills on time accounts for 35 percent of your rating, while the remaining debts you have account for another 30 percent. Other factors include the length of time your credit history has been established, the number of recently opened accounts and the types of debt you have. For example, car loans and mortgages show that you can manage larger debts, while credit cards reflect your responsibility with smaller loans. Also, the longer you have been paying off your debts on time, the better your credit rating is.
Effects of Good Credit Ratings
An April 2009 "Newsweek" article examined the benefits of borrowers who have scores of 750 or greater. It points out that these borrowers get the lowest APR, or annual percentage rates, on credit cards and mortgages, meaning they can save more money in interest over time. Lenders are more likely to lower rates to entice borrowers who have great credit because they are more likely to pay back loans in full. In contrast, borrowers with bad credit are more likely to declare bankruptcy or miss payments. Therefore, you should take the time to pay off debts and improve your credit rating before shopping for new credit cards, mortgages or car loans. By reducing debts, you can boost your credit rating in as little as a few months.
Member Comments