Have you ever wondered what the financial institution is based on when granting or rejecting a loan? Generally, these entities use credit scoring systems to determine if you are a good candidate to obtain a loan . In this article we will know what the credit score is , how it affects our credit and what we can do to improve it.
What is the credit score?
The credit score is an automatic system that, based on a given information, recommends the approval or not of a financing operation. It is a method that is being used more and more frequently among financial institutions to measure the risk of granting loans .
The credit score is a three-digit number that is based on the information in the credit report about previous credit experiences, such as payment history, collection actions or outstanding debts.
Using a statistical program, credit grantors compare this information with the payment history of other consumers with similar profiles and “predict” the payment capacity of the credit applicant.
There are different types of credit scores or scores, each developed for specific evaluation purposes. In Chile, the generic risk score for people contains socio-demographic information, and commercial and credit history.
The most popular credit scoring system is the FICO score , which is a type of credit rating that was created by the Fair Isaac Corporation. It is estimated that around 90% of financial institutions in Chile rely on this system for their credit score.
A good credit history is essential to obtain the approval of credit cards, mortgage loans and auto loans, among others. The credit history and the score also determine the interest rate that will have to be paid on the credit accounts. Thus, people with excellent credit history may have approved their loans with preferential interest rates, while those with a bad history will pay higher interest for their greater risk of default.
What factors determine the credit score?
Credit scores are generally based on the following factors to grant your score:
- Payment history. It refers to whether an individual pays his credit bills on time or not. The shorter the time the payments are made, the more score you get in this parameter. This is the factor that contributes most to the FICO score, 35% of the total score.
- Accounts owed. It refers to the general amount of money a person owes. Consider the proportion of money owed to the total available credit. This factor contributes to 30 percent of the FICO rating.
- Duration of credit history. The longer the credit history, the higher the score for this factor. The time that the oldest account has been opened, the age of the most recent account and the general average are taken into account. This factor contributes to 15% of your FICO rating.
- New credit accounts It refers to accounts opened recently. If the borrower has opened many credit accounts in a short period of time, it could become a high risk for the lenders. This factor contributes to 10 percent of the FICO score.
- Credit Mix It refers to the amount and variety of credit accounts that the person has. To obtain high credit ratings, it is necessary to have a solid mix of accounts, credit cards, credits, etc. This factor also contributes to 10 percent of the FICO score.
The following image shows, schematically, the different factors that determine the credit rating of the FICO score and its weights:
What is a good credit score?
Credit scores typically vary between 300 and 850 points. The higher the score, the better the chances of obtaining favorable credits.
Within the range of 300 to 850, there are different categories of scores, which generally include:
- Below 600 points: bad credit
- Between 600 and 649 points: poor credit
- Between 650 and 699 points: fair credit
- Between 700 and 749 points: good credit
- 750 and more points: excellent credit
Thus, it is recommended that our credit rating be above 700 or 725 points.
However, it is necessary to specify that different lenders can use different credit scores , so a score that one lender considers as good, for another it could be a fair or poor credit.
How can I improve my credit score?
As we have seen, credit scores are complex and may vary depending on credit grantors, but generally, these are some of the aspects that must be taken into account to improve the credit score:
- Paying bills on time is one of the most important aspects of having a good credit score. If you fall behind in any payment for any problem or forgetfulness, get up to date with payment as soon as possible and the rating will improve gradually.
- In case you find difficulties in dealing with your debts, contact your lender and try to negotiate them or, where appropriate, request an increase in the credit line.
- Always be sure to take into account your credit card quotas and always be below the maximum allowed.
- Not closing old credit accounts, contrary to what is usually thought, helps improve the credit score. The longer you have your accounts, the more you will add to your score.
- After acquiring a new debt, wait a prudent time before requesting another loan, so that your cash flow adapts to the new obligation.
- Contrary to popular belief, consulting credit history does not lower the score. In fact, it is essential to review it at least once a year, so as not to have unpleasant surprises when you are going to make a great investment.
Therefore, it is important to be aware of the factors that affect our credit score , since the granting of the credits we need to obtain will depend on this. Making debt payments on time and not having large amounts owed is essential to have a good credit score.
Do you have any doubt? Do you need more information? If so, you can comment below and we will be delighted.