Nowadays, people are becoming increasingly dependent on credit to make purchases and financial decisions.
Why has this become a norm? Well, although many people are working hard to pay their bills on time, a large percentage are increasingly relying on more easily attainable credit just to keep their heads above the water. Of course, this has exposed them to the risk of tumbling in huge debts.
Because of this, many lenders are becoming skeptical in matters regarding credit. It has become paramount for people to have a good credit score in order to obtain credit. In fact, some businesses have made it compulsory that one must have a good credit score before they extend their products or services.
If you’re planning to obtain a credit card, a mortgage, or a loan to buy a car, it’s important that you understand what credit score is and factors that can impact on your credit score. In this article, we explore several important things concerning credit score.
What is the Difference Between a Credit Score and a Credit Rating?
Although credit score and credit rating are often used interchangeably in some cases, there is a distinction between the two phrases.
A credit score is basically a statistical number that is used to evaluate a consumer’s creditworthiness, and is based on credit history. When you use credit, you are basically borrowing money with a promise to pay it back within a specific period of time. Therefore, in other words, a credit score is used to determine the likelihood of an individual repaying the money that he/she has borrowed.
On the other hand, credit rating is an assessment of the creditworthiness of a borrower either in general terms or concerning a particular financial obligation or debt. Any person who seeks to borrow money is assigned a credit rating- can be an individual, a business, corporation, state or provincial authority, or the government.
How is Your Credit Score Calculated?
Your score is determined after calculations of the information available on your credit report are made. The score is generated by plugging the data from your credit report into a FICO Score, a software that analyzes it and gives out a number. That’s why credit score is commonly referred to as FICO score.
The tool is created by Fair Isaac Corporation and is commonly used by many lenders to determine the score of borrowers. The score’s calculations are divided into five major categories, all with varying levels of importance.
The criteria used include: payment history (35%), the total amount owed (30%), the length of credit history (15%), new credit (10%), and the type of credit used (10%). From these categories, your overall score is calculated.
Credit scores usually range from 350 (extremely high risk) and 850 (extremely low risk).
Do Short-term Loans Affect Your Credit Score?
Short-term loans happen to be one of the few financial solutions that can help individuals with bad credit. This is because many payday lenders don’t run credit checks on borrowers.
Although these loans come in handy during emergency situations, a number of factors can negatively affect your credit score. These factors may include failure to make repayments on the loans, the number and frequency of credit inquiries, the amount applied for, type of lender, type of credit account, and other factors.
In fact, a short-term loan is given more weight by lenders compared to bank mortgages, which contributes to low score.
What Has the Biggest Effect on Your Credit Score?
There are five key factors that affect your score. They include:
- Payment history (35%)
- Total amount owed/level of debt (30%)
- Length of credit history (15%)
- Type of credit in use (10%)
- New credit (10%)
These are also the same factors used to calculate your credit score.
Is it Bad to Check your Credit Score?
There are two types of credit score inquiries: Hard and soft inquiries. When a lender obtains a copy of your credit report in response to your application for credit, this counts as a hard inquiry. On the other hand, when a prospective employer or any other person pulls your credit report, it counts as a soft inquiry.
Checking your own credit counts as soft inquiry, meaning that it won’t hurt your score no matter how many times you check.