How Does Your Credit Rating Affect You?
How Does Your Credit Rating Affect You?
A credit rating is simply an assessment of an applicant’s credit risk, projecting their likelihood of defaulting on their debt, and predicting their ability to repay the loan. There are several different ways that these ratings can be calculated, but they all share a common element: they use statistical models to evaluate a person’s credit profile against a base of information regarding their credit history. These models are designed by companies that specialize in credit risk and are called credit scoring models.
People who have a high risk profile in the credit market are usually offered lower interest rates, fees, and penalties, as well as more favorable terms on their loans. They are typically the type of clients who are most at risk for being turned down for credit or even having to take a lawsuit to recover money that has been lost due to their default.
Once the companies know what kind of people are most at risk, they can develop special credit score models that calculate their risk profile in various ways. They may also use a multiple regression model, where multiple predictors are combined to create a single predictive model, which they then analyze.
Most financial institutions require their loan applicants to pass credit scoring tests. Banks and other financial institutions may use various methods to determine the riskiness of their loan applicants, including credit history, credit scores, employment history, income, and other factors. When applying for a bank loan, it is important to meet the criteria set by the bank, as there may be a limit on the amount of credit that can be extended to someone who is considered a high risk customer.
It may be helpful for the applicant to know that lenders use different scoring techniques when calculating their credit score. If you are looking for loan approval, it is important to know how to use one of these scoring techniques to improve your credit rating.
Credit score formulas are based on the mathematical algorithms of several statistical models, including those designed by Standard & Poor’s (S&P) and Moody’s. Each scoring formula takes into consideration the age of each individual borrower, their payment history, and their past financial behavior, as well as many other variables.
Standard & Poor’s models use a two-step approach, beginning with an analysis of income and family income, followed by a calculation of debt to income ratios and a detailed comparison of a borrower’s credit worthiness against other borrowers. By using this standard approach, they are able to produce a fair but detailed credit scoring model, which can accurately predict a person’s ability to repay any debt, including any home mortgage debt or credit card debt. based on the information from his or her income, debt to income ratio, and payment history of late payments and defaults.
The Moody’s credit score approach, on the other hand, uses a different approach called the HECM score, which is a statistical model which uses income, debt to income ratio, credit card and home loan delinquency history, credit score, the types of debts that a person has, the debt to credit ratio, and other factors to calculate an estimated credit risk level for each individual. The model then assigns a credit score, with the lowest score reflecting the highest credit risk, based on these variables and the information in its database.
A person who has good financial reputation, stable employment, and a steady source of income will typically receive a better score than someone with a poor record. Because this score is usually lower than the others, it tends to be used by lenders as an indicator of riskier borrowers.
If you have a poor credit rating, it is important to have a good credit history to show the lender that you are taking reasonable steps to rectify your credit situation. Lenders will consider a variety of factors when determining your credit risk score, such as: late payments, default on a loan, bankruptcy, or any other form of adverse financial behavior, and/or having a history of fraud in one or more areas.
As a borrower, you may have no choice but to take the risk that your credit rating formula may give you a lower score. But if you understand the scoring formula and follow it closely, you can work to increase your score over time.