Would you loan money to a friend if you knew that they had a propensity for not paying their debts? It's doubtful, and the same rule applies when lenders consider loaning you money for purchases like homes, automobiles and big ticket items. It's true: your credit score stands between you and your next major purchase.
The concept of credit started back in 1956 with two men named Bill Fair and Earl Isaac. Fair, a mathematician, and Isaac, an engineer, founded the Fair Isaac Company; otherwise, known to us today, as the FICO score. This credit system has standardized the way the financial industry extends "credit".
As a result, there are 3 national credit programs at 3 different bureaus:
- Fair, Isaac Model at Experian (formerly TRW)
- BEACON at Equifax
- EMPIRICA at Trans Union
Beacon and Empirica, both subscribe to the Fair Isaac's FICO model of scoring and then they integrate their own version of a person's FICO score. On the other hand, when borrowers are looking for a mortgage loan, lenders pull what's called a "tri-merge". A tri-merge merges and verifies all information detailed from all 3 unions into one report.
The main determinants of a credit grade are based on your credit and debt ratio. Beacon scores range from 400 - 844; while, FICO scores range between 350 - 880. Conversely, lenders determine the investment quality of a loan, with the equivalent of a grade, A, B, C or D. y 'A" paper represents the highest quality loan, and D paper is the highest risk loan for the investor.
For example, if your credit score is 680 or more, you fall in the 'A' paper category; however, not all lenders rate credit the same way. So the question is : how does your credit affect the interest rate a lender will charge you? The answer depends on the level of the consistency of good payment in your credit history, along with your debt ratio. If both are great, the loan is assigned an 'A' grade; and, qualifies for the best interest rate. If even one of the factors is not up to par, the quality of the loan is downgraded to 'A-" or 'B' paper. Consequently, the interest rate goes up as the perceived risk factor increases. There is a higher risk for a lender making a B, C or D paper loan because there is a higher risk for a defaulted loan. Therefore, the lender is compensated for the higher risk by charging the borrower a higher interest rate.
When lenders review one's credit score, it's reviewed by an underwriter. The underwriter and credit scores are assessed and rated by the following criteria:Lifestyle History
- How long you've lived at your residence
- Do you own or rent (Owning property - earns extra credit)
- How long you've been employed at your current job
- Education level (College Education - earns extra credit)
- How much money earned and how credit has been used
- Public record and collection items
- Severity, recent and frequency of delinquencies noted in trade line section
- Credit history
- Number of balances recently reported
- Average balance across all trade lines
- Relationship between total balances and total credit limits on revolving trade lines
- Number of inquiries and new account openings in the last year
- Amount of time since most recent inquiry
- Number of trade lines reported for each type Bankcard
- Department store cards
- Personal finance company references
- Travel and entertainment cards
- Installment loans
- Obtain Your Credit FICO Score
- Make any credit corrections with the proper documentation
- Pay off small balances on high limit credit cards
- Consolidate credit card bills onto fewer credit cards
- Cancel certain credit cards and shift the balances onto fewer cards. (Shifting small balances to fewer cards raises the ratio of your unpaid balances).