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How Lenders Use Credit Scores to make loan decisions

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Credit scores form the backbone of any or almost all the lending decisions taken by the lenders. Credit score is calculated on the basis if the information available in the credit reports of the individuals. In fact the three credit bureaus, namely Equifax, Experian and the Transunion are into the business of getting the credit score calculations for the people. With the 3 bureaus, the credit reporting agencies are different and hence there is always a difference in the credit scores of an individual when referred to the credit bureaus separately.

Your credit score is a three digit number, calculated using complex mathematical formulas which takes the credit information stored in the credit report at the base of it. The number is taken as the parameter of the financial credibility of an individual. For the lenders it means how likely are you going to make the repayments of the loans you take from them.

No matter what is the kind of loans you take be it mortgage, auto loans, the credit score is checked before the approvals. Nowadays even in the credit card approvals, insurance, the credit score decides the insurance premium and the credit limits you will be offered by the credit card companies. Anyone with a higher credit score is likely to get better deals when it comes to any of the financial services they avail.

Determining Credit Risk

Credit scores offer several indicators about an individual’s financial behavior and credibility. Let us take an example to understand it better. John has been making regular payments towards the mortgage loan taken for the past 24years.  he hasn’t taken any new debts. There are no defaults, delay in payments, CCJs or bankruptcies in his credit report. On the other hand, Roger, has four cases of delayed payments on the two credit cards in his name. He has already maxed the credit limit on the two cards. The credit report shows multiple enquiries related to new credit card applications. He is likely to have a lower score as compared to John.

The US uses the FICO system of credit scoring. Under this scoring method, different weight age is assigned to the several components of the credit report.

Why Lenders Use Credit Scores

Prior to the credit scores, the lenders took a detailed view of the credit reports of the applicants. They would look at the payments made, debts taken , debt requests under consideration and several other details which included the payment trends, any late payment details, defaults or bankruptcy, any liens, judgments and all. All this gave the lenders a clear idea of the financial credibility of the individuals. However, at ties the lenders got biased and took wrong decisions. At other times it was the human touch which often saw borrowers being rejected for the no credit check loans they wanted desperately.

With the advent of the credit scores, the lenders are no more required to get deeper into the credit report of the applicants. All that they look at is the credit scores and decide the lending call.

Understanding Credit Scores

In the recent times, financial crisis has made people aware of their finances and the way to deal with them. With the government support people can have access to their credit report free once a year from any of the bureaus. All this had made people aware of their credit score and the way they affect our lives.

Finally, one should remember that the credit scores are dynamic. Any negative entry in your credit report can affect the credit score negatively. Fixing credit score is no easy task as it takes months to regain the lost numbers.

Category: Debt Management