You’ve probably heard the term “credit score” mentioned in a financial context, and maybe you’ve even used your credit score while applying for a loan, job, or mortgage. But have you ever wondered what a credit score means and why it’s so important? If you have, your curiosity stops now; read on and learn what your credit score says about you, and how institutions in the financial sector use your credit score to determine certain services and products.
What is a Credit Score?
A credit score is a value that represents your lending risk. The score is carefully calculated for each individual by credit bureaus. The formula for calculating credit scores considers several factors, which include, payment and borrowing history, financial accounts, owed amount, and loan history.
The classification of credit scores varies with the bureau processing the variables. Some bureaus use stellar systems to quantify credit scores, while others use numeric variables. The most generally accepted and commonly used classification style is the 300 to 850 numerical range. This method is used by major credit bureaus like FICO and VantageScore.
Under the 300 to 850 scoring system, the following distinctions are given to specific score ranges;
- 720 to 850 – exceptional or excellent credit score
- 740 to 799 – very good score
- 670 to 739 – good credit score
- 580 to 669 – fair or average credit score
- 350 to 579 – poor credit score
- Under 350 – no credit score (you have no credit history or haven’t established a credit account)
People with a score that’s above the good credit score threshold (670) are considered to have a low lending risk; they make most or all their loan payments on time and have no blemishes on their credit history. On the other end of the scale, anyone with a poor credit score (below 580) is considered a high lending risk and may have a history of poor loan repayments.
Sitting in the middle of the pack is the fair or average credit score zone. Individuals who fall in this zone are not very good at making loan repayments, but they are not as bad as those with poor credit scores.
What Effects Does a Credit Score Have?
There is definitely has to be a good reason for credit bureaus to go through all the trouble of collecting and analyzing people’s financial information to come up with their credit scores. Below are the ways that a credit score influences service and product deliveries in specific business sectors, and also how your credit score affects you.
Loans and Financial Services
The primary purpose of a credit score is to show your lending risk. In other words, how likely you are to pay off a loan on time. Before a bank or any other similar financial institution can give you a loan, they first review your credit score as one of the most important financial assessment. Your credit score can solely determine the loan terms, the loan amount, and whether the lender will even grant you the loan in the first place.
With a good-excellent credit score, you’ll probably get some favorable terms on your loans, such as an extended payment period, low interest, and no insurance or collateral. You’ll also get a favorably high loan limit. With an average score, you’ll have generic terms on your loan without too much wriggle room. With a poor score, you might not get the loan at all, and if you do, it will have several strings attached and will probably come with a high-interest rate.
Some financial institutions don’t care about the borrower’s credit score, but they often have restrictive loan products and high interests, most of them also require collateral to secure loans. These are usually short-term low-principle loans like payday loans.
Similarly, it is important to remember that in some cases, credit cards can affect your credit score. From the application process right through to your usage habits, payment history, and beyond, credit cards can play a significant role in how your credit scores are calculated. With this in mind, when applying for credit cards, it is sometimes best to choose personal finance companies like SoFi that conduct a soft credit pull, as this will not affect your credit score. Correspondingly, you can learn more about the relationship between credit scores and credit cards by taking a look at some of the useful resources on the SoFi website here: https://www.sofi.com/credit-
Insurance Terms and Premiums
Most insurance companies also consider credit scores when determining their clients’ risk factors. A credit score is an important consideration, particularly in auto insurance and life insurance. With life insurance, however, it’s not the exact score that carries the most weight, but the information in your credit report can be used to determine certain terms of the life policy.
Auto insurers consider people with poor credit scores to have a higher risk than those with good scores. Individuals with poor credit scores are more likely to make auto insurance claims than their counterparts. So, ultimately, if you have a good score, you’re likely to get some good terms, discounts, and even lowered premiums of your car insurance policy.
Mortgages are treated more or less the same as long term loans. Although they are a bit different from regular loans, lenders still look at your credit score before deciding on the mortgage amount and terms. Similarly to loans, a high credit score earns you leniency with the lender, and you might end up getting the full amount you ask for, low interest, no mortgage insurance, and a flexible payment schedule.
Nowadays, due to competition in the labor market, employers are looking for new ways to scrutinize candidates for job openings. One of the filtering methods involves using credit scores to separate worth candidates from the rest. A good credit score might be just what guarantees you a shot at your dream job.
Rental or Lease Application
If you want to lease a house, apartment, or building, the landlord might use your credit score to determine whether you would make a “good tenant.” The landlord may want to make sure that you’d be able to pay rent or lease on the property or living space, and a credit score is, in most cases, a good judge of financial abilities. A landlord is in his/her legal right to choose tenants using whichever reasonable means necessary. So, it’s possible to be turned down for a property lease or rental due to a low credit score.
A credit score is more than just an indication or lending risk. It has become a method of judging character in both social and professional settings. Some people go as far as to distrust those with poor credit scores and regard them as irresponsible. Although such attitudes are often misplaced, it’s still a good effort to maintain a good credit score.