How Do Banks Determine Your Credit Score?

A credit score ranges from 300 to 850 and is used by lenders to identify the likelihood of a borrower paying their debt obligations. Scores closer to 850 mean that the borrower has a history of settling their debts on time.

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Many factors determine the credit score, including credit history and the number of accounts one has. The Fair Isaac Corporation (FICO) established the credit score model; other scoring models are available, but FICO is the most commonly used.

How Are Credit Scores Used?

Whenever you apply for a loan at a financial institution, including a bank, the lender refers to your credit score to determine whether to lend to you or not. If your credit score is low, the likelihood of you getting a loan is slim–and vice versa. It's therefore essential to ensure you have a healthy credit score.

Contrary to popular belief, financial institutions aren’t the only ones checking credit scores. You'll be surprised to learn that your phone company, water company, insurance company, and even your landlord can refer to your credit score to determine your creditworthiness–a low credit score results in you incurring high-interest rates and having more trouble getting loans.

How Do Credit Scores Work?

People with a credit score of 640 and below are considered high-risk borrowers. As such, financial institutions charge them high-interest rates; they may also request that the borrower repay their loan in a shorter period of time.

On the other hand, a score of 700 and above is considered good, which can mean paying a lower interest rate for your loan and getting flexible repayment plans, while a score of 800 is considered excellent. Here’s a simple breakdown of the FICO credit score:

  • 800 to 850: Excellent

  • 740 to 799: Very good

  • 670 to 739: Good

  • 580 to 669: Fair

  • 300 to 579: Poor

Your credit score affects how high your interest rates are determined, the amount you may borrow, and the initial deposit amount you pay when paying for a high-price item such as a home or a car. To find your credit score, you can typically get free copies of your credit report without hurting your score.

What Affects Your Credit Score?

A person's credit history is collected, reported, and updated by the three main credit bureaus in the United States: Equifax, Experian, and Transunion. While the three credit bureaus used different methods to make their determinations, five main factors affect an individual's credit score:

Payment history: A borrower will most likely look at the likelihood of you paying your bills by researching whether you've paid your bills in the past. Late payments affect your credit score negatively.

Amounts owed: Credit utilization is one of the most common terms when speaking about amounts owed–it refers to the total debt you owe vis-à-vis your credit limit. It's recommended to keep your credit card balance at 30% or less to improve your credit score. Maxing out your cards will negatively affect your score.

New Credit: If you’ve recently taken out several new loans from different financial institutions at once, it may indicate to the lender that you're in economic turmoil and you're more likely to be considered high-risk.

Credit mix: Financial gurus recommend having different types of accounts, indicating to lenders that you can manage other lines of credit such as credit cards, installment loans like auto or personal loans, or even mortgages.

If you find any inaccuracies in your credit report, it is in your best interest to clean up your credit report. This can be done by filing disputes with the credit bureaus and proving paperwork to prove the inaccuracies. However, this process is lengthy and time consuming with lots of complex financial documentation–fortunately, the best credit repair companies, like The Phenix Group, can help by removing the burden of waiting on hold with the credit bureau and filing mounds of paperwork.

Final Thoughts

A credit score is essential because it indicates to lenders your creditworthiness. If you're having difficulty borrowing or are being offered loans with high-interest rates, there's no time like the present to turn your fortunes around. You can improve your credit score by paying your bills on time, increasing your credit card limit, putting a pause on a credit card you're not using, and, of course, working with a reputable credit repair company.

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