A lender uses credit scores to determine the terms of loans and whether or not to advance the funds. Further, the rate enables a lender to hedge against losses accrued to defaults and bad debts by appropriately pricing the services.
Credit scores are determined by analyzing the credit reports of a borrower. Currently, the Fair Isaac Corporation index (FICO) is widely used by lending institutions. To determine the creditworthiness of a person, the score introspects five aspects;
- Repayment history.
- Types of credit owned.
- The current level of indebtedness.
- New credit applications.
- Length of credit history.
The FICO score ranges between 300 and 850, where 300 is very low and 850 is exemplary. The score is calculated on the following basis;
- 35%- On time payments.
- 30%- Capacity used.
- 15%- Duration of credit history.
- 10%- Types of credit held.
- 10%- New credit applications.
It is important to point out that the mathematical formula has never been disclosed by the Fair Isaacs Corporation for patency right purposes. For a borrower to get a score, the person has to give out some information and expect a score after a given amount of time.
The Following are the Scores and What they Mean to a Borrower;
- 1. Below 300: No Credit
This individual has never taken a loan and there is no sufficient data to compile a credit score. Additionally, the borrower could have caused a lender to have a bad debt on more than one occasion.
- 2. 300-579: Very Poor Credit Score
An individual scoring below the figure is considered unfit for credit and in most cases, there would be an outright rejection. The score means that the prospective borrower has defaulted on loan repayment and has accumulated debts.
- 3. 580 to 669: Average Credit Score
The score means that although the individual struggles to repay loans, the person can be trusted as the chances of bad debts are almost null. However, the credit is risky and the rates will be very high. The individual can get short-term personal loans.
- 4. 670 to 739: Good Credit Score
This score is good. It means that an individual is capable of living up to the agreement. However, the borrower cannot qualify for certain loans that require huge amounts of repayments such as mortgage rates, corporate credit. The rates are standard and fair.
- 5. 740 to 799: Very Good Credit Score
The score means that an individual has low debt to income ratio, has been paying on time, has a history low credit balances among other factors. Additionally, the reports show that the individual has a history of successfully paying of loans such as auto and student loans on time. The individual is not a risky borrower.
- 6. Exceptional Credit Score: 800 to 850
The individual is creditworthy in every sense possible. The borrower can get the most competitive rates and can access most all times of loans depending on the amount applied for.
How to Improve the Scores or Get a Loan
Despite the scores, a borrower can prove to the lender that he/she is capable of managing a loan by presenting proof of improved and stable income, improved mental health after treatments and so on, provided that the proof is relevant. Additionally, one can practice the following;
- Cutting on unnecessary expenses.
- Using loans for the purpose intended.
- Paying the loans on time.
- Renegotiating the terms of service if an unexpected event occurs such as loss of job, a death of a spouse, unforeseen expenses such as medical bills and so on.