What is credit scoring?

When a lender decides whether or not you qualify for one of their loans and at what interest rate, they look at what is known as a credit score. These credit scores are created through a number of different mathematical formulae, but are usually provided by three major credit bureaus:

• Experian
• TransUnion
• Equifax
They provide you with a number on a scale of 300-850 that tells lenders how risky you are as a borrower.

 

Credit scoring takes the information on your credit report and compares it to similar people with the same general characteristics. It takes a great deal of data and runs a risk assessment which tells it how likely it is that you will be able to make all of your credit payments as well as how much you can handle. For example, imagine two people owe the exact same amount in loans. One individual, however, owes 6 different lending agencies smaller sums of money that totals that amount, while another individual has one giant loan. The data suggests that the individual with several smaller loans poses a greater credit risk and his or her credit score will be negatively affected.

In addition, things like past payment history and total amount owed also affects your credit score. All of these are taken into account in one giant algorithm for creditors to look at.

Credit Scoring Models
All credit scoring models provide weighted values to different aspects of your credit. For example, your ability to pay back your loans on time is more important than owing less money, so it is factored into your credit score most positively. All of these predictors are based off of the data from previous borrowers, and since these credit scoring companies have access to information on the credit history of the majority of the western world, the data they use to calculate these scores is not small.

What Score Do I Want?
Ideally, you will have a credit score over 700. 700+ implies that you are good at paying back your lenders on time, you do not owe a great deal of money to any lender, and you do not have a large number of credit sources that you need to keep track of. The closer you are to 850 the better, but very few lenders expect you to have a credit score near the mid 800's. You at least want a credit score of 700, though 750 is more preferable.

What Affects Credit Scoring?
Again, credit scoring agencies have their own secret algorithm for calculating your credit score. But you can bet that the following factors increase how your credit score is produced:
1) Your overall payment history (how often you made payments on time and whether or not you paid the full amount or more than the full amount).
2) How much you owe overall
3) How long you have had credit - this is not necessarily related to your age. If you have had credit since you were 18 and you are not 25, your credit score is likely to be the same as if you had credit since you were 25 and are now 32 - though there may be other age related factors involved, like income.
4) CCJ's, Bankruptcy, Insolvency or any other significant red marks in your credit.
5) Percentage of credit used as well as percentage of credit available.
All of this information will affect whether or not you are a good candidate for a loan and how high your interest rate is.
 

Credit scoring is meant to be your friend and not your enemy, but it can seem like it is out to get you. Just remember that all credit scoring is a numerical depiction of risk. If you do not do any of the behaviors that allow credit agencies to believe that providing you money is a risk, you are likely to have a higher credit score.




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