Whether you want to upgrade the credit limit of your card or you want to file a business or personal loan application, your credit score will be a crucial factor. Your credit score is a reflection of your credibility and capacity to pay the debt. It is a statistical number that allows lenders like banks to assess the risk of defaults or non-payment of loans.
You can improve your chances of being granted a loan if you know where you stand, financially speaking. Your credit score will also help you prioritize which aspect of your financial standing can be effectively addressed and how.
Learn about the credit score systems of banks
Banks and other lending institutions use various systems of assessing credit scores. The Fair Isaac Corporation (FICO) credit score system is commonly used. The system promotes a scoring range between 300 and 850.
You should know the system being used by the bank or lending company to which you are applying for a loan. This way, you will be able to do a self-assessment.
Various lending institutions that use the FICO system typically have their own classifications, but the following categories of scores are generally used:
- 750 and above – EXCELLENT
- 700 to 749 – GOOD
- 650 to 699 – FAIR
- 550 to 649 – POOR
- 550 and below – BAD
Your credit score will determine whether your loan will be granted or not. It also determines other details of the loan, such as the interest and the repayment term. You are also likely to be required to have a co-borrower or co-signer if you have a low score.
Know the different factors that can affect your score
Several factors are considered by lenders in order to assess your viability as borrower. These factors can be examined and ranked based on your credit history as supported by the documents that you are required to submit. In some countries, data about credit history can be obtained from credit reporting agencies.
The factors that are examined to determine your creditworthiness are the following:
1. Payment history
This includes information on the number of times you defaulted on payments for credit cards, car loans and mortgage. If you regularly pay on time or at least have very few defaults, you can have a higher score.
Most lending companies and banks assign a higher percentage on the credit history as basis for your score. As much as 35% of your credit score could be based on the payment history. If you regularly pay your loans on time, it indicates that you are responsible and you have the capacity to pay.
2. Total amount owed
As much as 30% of your credit score could be based on the total amount you owed. A higher amount means that lending institutions trust you. It could be an aggregated amount from several banks or from just one bank. Banks typically do not give a high amount of loans to clients who are not deemed creditworthy.
So, if you took out one big loan for a business and you paid it on time, you will have a higher credit score. Even if the amount is aggregated from several smaller loans from various institutional lenders, it still indicates trustworthiness.
3. Length of credit history
The length of your credit history will be the basis of an estimated 15% of your credit score. A longer credit history can lead to a better score than a shorter one. Lenders see lower risk if you have a long history of borrowing.
4. Types of credit
If you have various types of loans such as car loans, mortgage and credit cards, this indicates that you qualified for the various requirements. It means that many lenders trusted you. Provided that you paid all your loans or continue to pay regularly, an assortment of loans is used as basis for 10% of your credit score.
5. New credit
Finally, the remaining 10% of your credit score is computed based on your latest credit. This includes the number of new accounts you applied for and how many of those were approved or rejected.
Calculate your creditworthiness
Before applying for a loan, you can estimate the likelihood that your application will be approved. You may use the loan eligibility calculator provided by banks on their websites. This will save you time and provide helpful insight into how banks can assess your financial capabilities.
Knowing your financial standing will help you plan and prepare to apply for a loan. You can also address the aspects that need to be improved.