Learn how the credit score works and how it is

When a person borrows a certain amount of money with the commitment to return it in a defined time, they are acquiring a credit obligation (loan or credit). Since some people are more likely to repay what they borrow than others, lenders need to have an objective tool to identify these types of people. This tool is known as a score or credit score.

The credit score in charge of measuring the risk of non-payment is the sum of points that a person obtains for their good payment habit, that is, the good and bad credit decisions made, add and subtract points respectively. People are classified into risk groups through the score, thus differentiating between wrong and excellent customers, known as risk segmentation.

WHAT USE DOES IT HAVE?

The benefits of having a good credit score are varied and relevant. For example, it allows a person to access higher amounts of credit at a lower price (lower interest rates) and more efficiently. Additionally, credit score is widely used in different areas.

HOW IS IT DETERMINED?

The score or score of a person or company is determined by considering the following main areas:

  • Payment history:  if the payment is made on time and in full.
  • The amount owed:  answers the question, how much do I owe?
  • Experience:  credit history time.
  • New credits:  new open credits.
  • Types of credit:  different payment risks of the different types of credit.

The interaction of the listed criteria allows each person to be assigned different scores. For example, a score above 930 points identifies an excellent customer. In contrast, a score below 400 determines a bad one—the importance of the described areas on the score obtained by a person or company.

Payment history is the most critical category (40%) and awards the most points. This area adds points for paying the fees on time and in full. For example, a car financing fee, credit card payment, internet payment, cable or telephone plan, etc. However, if a person is late in an installment or payment, points are deducted from their credit score.

The second most important category is the amount owed (25%). The credit score evaluates the amount that a client owes on all their accounts and analyzes the relationship of the amount owed with the availability of credit linked, among other aspects, to the ability to pay. In short, the customer will be awarded more points the less he owes; and issues will be deducted the closer you are to your credit limit.

The experience, which corresponds to the time of your credit history, is the third category (15%) to add points to the credit score. The longer the history of responsible credit use, the more points a customer receives for this area.

Finally, the other two categories used to determine the credit score, creation of new accounts, and types of credit, are less critical. They represent 10% of your score each.

WHO PERFORMS THE MONITORING AND MAINTENANCE OF THE CREDIT SCORE?

The credit bureaus are the organizations in charge of maintaining the record of the activity and credit history of the people, mainly evaluating the payment habit in the obligations contracted. The credit bureau collects the most outstanding amount of information available to assign the most reliable score possible to each person since this it provides a report to lenders with the detail of the client’s credit history, credit score, and additional information relevant to decision-making in granting or not granting a loan to applicants, which is known as a credit report.

Leave a Reply

Your email address will not be published.