Understanding Your Credit Score and How It Affects Loan Approval
Before approving a loan, banks resort to various checks to assess the reliability of the future borrower. This allows you to find out whether the client pays off his debts accurately, whether he is prone to delays, and whether you can trust him with a large sum of money at all.
One of the main indicators the creditor pays attention to is the borrower's credit rating: a financial indicator that allows the lender to assess a person's ability to repay the loan. How the credit rating is structured in the USA and how it affects loan approval — read further in the article.
What is a Credit Score?
A credit score is a numerical value based on a statistical analysis of a client's credit history. It aims to reveal the client's creditworthiness—whether they can regularly pay the monthly payments. Credit scores are based on credit records from credit bureaus such as Experian, Equifax, and TransUnion. Both bank and non-bank lenders widely use credit scores to assess a client's potential risk and decide to issue a loan.
Several types of credit scoring are used in the United States (including various versions of the FICO score and VantageScore), with all major systems using a scale from 300 to 850 points. Scoring from one of the credit bureaus is usually used to make decisions about issuing a loan. The most popular model is FICO — it is used by about 90% of American lenders.
Scoring is mainly calculated by taking into account five factors:
- Payment history.
- Debt.
- New credit applications and credit history records of issued loans and applications.
- Length of credit history.
- Variety of used loans.
The Basics of FICO and VantageScore Credit Scoring
FICO and VantageScore are two ways to assess your credit history. Both show your credit score in a range from 300 to 850, but they calculate it differently.
| FICO/VantageScore | FICO | VantageScore |
|---|---|---|
| Exceptional/Excellent | 800-850 | 781-850 |
| Very Good/Good | 740-799 | 661-780 |
| Good/Fair | 670-739 | 601-660 |
| Fair/Poor | 580-669 | 500-600 |
| Poor/Very Poor | 300-579 | 300-499 |
FICO is a scoring system that looks at how you manage your debt: whether you pay on time, how much you've borrowed, and how long you've been borrowing.
VantageScore works a little differently. It looks at your payment history, how many open accounts you have, how much credit you use, and how actively you apply for new ones.
Why Do You Need a Credit Rating?
The indicator is primarily important for credit institutions where people apply for loans. Creditors, having received a loan application, cannot analyze in detail the credit history of each applicant; it is much easier to take into account the mark on the credit rating scale. This clarifies how responsible, disciplined, and solvent the client is. In fact, such an assessment is a general answer to the question of whether the borrower has a good or bad credit history.
But, although the credit rating is important, when approving loans, creditors also take into account:
- the level and source of a person's income;
- the ability to provide collateral, a guarantor, and a co-signer;
- the form of employment: a borrower who is officially employed and receives a good salary will always have an advantage over someone who cannot guarantee a stable income (for example, a freelancer).
Why is the Credit Rating "Falling"?
Unfortunately, even those who regularly repay their loans may face a low credit rating. Of course, in most cases, a decrease in credit rating occurs due to shortcomings on the borrower's part. This can be facilitated by:
- Poor payment discipline. Overdue payments on loans are the easiest and fastest way to ruin your credit rating. The more of them and the longer they are, the worse the credit history.
- High debt burden. As each new loan increases the burden on the borrower's budget, it becomes more difficult for him to repay them, which means that the credit rating indicator also falls.
- Debts and collections. Unpaid debts for which the collection procedure was initiated through the court are also reflected in the credit history and have a very strong effect (such marks can remain on the credit report for up to 7-10 years).
- Fraudulent activities also lead to a decrease in the credit rating. Sometimes, scammers issue a loan to another person, who finds out about it only when delinquencies have accumulated and the credit history has been damaged. If this happens, you should immediately contact the lender, lawyers, and financial consultants to prove you are not involved in such a debt.
Sometimes, the fault of a lowered credit rating may lie with the bank. In case of failures, the bank may not transfer information about payments or transfer it incorrectly to credit bureaus. This is recorded as a delay, and the borrower's credit history is damaged. There are also situations when, if the full name coincides, data on the delinquencies of one borrower can end up in the credit history of another. Both software failures and the influence of the human factor can cause such problems. To avoid such problems, you need to check your credit report and dispute such errors regularly.
How to Check Your Credit Score?
Your credit score helps you understand what loans are available to you and under what conditions. To avoid unpleasant surprises, it's important to check it regularly and correct any errors right away. Here's how:
- You can get your credit report from the three major bureaus for free each year at AnnualCreditReport.com.
- Many banks and credit card companies provide customers free access to their scores and helpful tools for analyzing their credit history.
- Nonprofit organizations like the Financial Counseling Association of America (FCAA) offer free consultations and help you get your credit report.
How to Improve Your Credit Rating?
There is no immediate fix, but there are several ways to improve your rating:
- Pay on time. This applies not only to loans, but also to utilities, fines, and other mandatory payments.
- Reduce the total amount of debt. The less debt you have, the better your credit rating.
- Don't apply for too many loans. Each application is recorded in your credit history and can lower your rating. Take out loans only when you need it.
- Reduce debt. Try to close high-interest accounts quickly and keep your credit card balance below 30% of its limit.
- Try a secured credit card. It requires a security deposit, but it helps build your credit history. The main thing is to pay the balance in full every month.
- Become an authorized user. Ask a loved one with a good credit history to add you to their card. This will improve your rating if they pay their bills on time and do not exceed the limit.
- Actively use credit cards. However, do not forget to repay your debt on time.
- Check your credit history regularly. Make sure there are no errors or incorrect information. This will help you identify problems and take steps to fix them.
- Set up automatic bill payment. This will prevent you from going late and will help improve your credit score.
- Don't rush to close old credit accounts. Old accounts show your financial reliability over a long period.
- Use different types of credit. This demonstrates that you know how to handle different borrowing options wisely.
Final Thought
A personal credit rating is a numerical indicator of the borrower's financial reliability. It helps banks and other financial institutions assess the borrower's creditworthiness and decide whether to issue him a loan. The credit bureau calculates the credit rating based on data from your credit history and other sources. A high credit rating for lenders means that the borrower is conscientious: he pays off all obligations on time and has a stable financial position. And it is better not to cooperate with someone with a low rating.
In order to be able to receive loans on favorable terms, you need to pay loan installments on time, reduce your debt, and monitor your credit history. If necessary, you can find out your credit history and rating by making a request on the BKI website.