Before submitting a loan application, you must always be sure about your credit score because credit scoring determines the eligibility to avail of financial transactions such as personal loans, business loans, auto loans, mortgages, and credit cards.
Today, every other financial institution, bank or lender analyzes your credit score before approving one’s creditworthiness. Credit scoring serves as the basis for lenders to either accept or deny a loan’s application. The credit score of an individual is a range of numbers between 300 and 850. The better the credit score better the chances to access a loan of any kind.
Five Reasons That Influence Your Score
This score is affected by five different reasons—your current debt status, your transactions/payment record, types of credit cards in your possession, any new credit availed, and the size of the loan. Amongst all these categories, one must pay special attention to his/her payment records and current debt status.
Financial institutes and other lenders analyze a person’s credit score in risk-based pricing, which serves as the basis to determine the term of the loan, interest rate proportional to the loan value, and the probability of repayment under a specific period. All-in-all, better the score better the chances of reasonable credit rates offered by a financial institution.
Credit Scoring Vs. Credit Rating
Another identical yet very different from the concept of credit scoring is credit rating. Although the two terms are often used interchangeably by institutions, there is a prominent distinction between the two, which is essential to understand.
While a credit score may be a number assigned to an individual or an organization defining the creditworthiness and eligibility qualify for a loan, credit rating on the hand is graded with a symbol that shows the creditworthiness of a government or business. Credit ratings express in triple-A, double-A, A, triple-B, double-B, B, triple-C, double-C, C, and D for default. A positive or negative sign may be added to differentiate between ratings from “AA” to “CCC,” where AAA corresponds to the most substantial capability of a government or business to comply with the financial requirements.
What Score to Maintain
Whereas a low credit score may not allow you better loan offers, it might also raise the interest rate, which is bad for any individual. Experian, a legitimate credit reporting agency, states that only 38.3% of loans in the third quarter were issued in 2018 to personals carrying credit scores of 660 or less. An average rating for borrowing a loan for a new auto was 717, while 661 was determined for used cars. The same goes for business loans for bad credit.
The Effects of poor credit rating
A bad credit score indicates that you are a defaulter. The adverse effects include high-interest rates, small credit limit, and the worst of all, outright rejection.
Lenders don’t always provide you the interest rate they advertise but instead based on ‘risk-rated’ pricing. Here, you get the rate determined by your previous credit score, which indicates the risk of paying back on time. Representative APR is shown often in advertising; in some cases, almost 51% of the people applying for the product pay the APR. However, in other cases, the lenders use the risk-rate pricing up to 49%, where all people asking will have to pay the APR at higher rates. It affects people with a low credit score or new to credit. It is always good to ask your lender about the interest rate and APR, before applying for a loan.
Effects of Credit Score on Your Existing Rate:
When you apply for a loan or a card, not only is your credit score checked, but you are also reviewed regularly to see if your rating or risk status has changed. If your credit score has worsened instead of improving, you might get charged with a higher interest rate. It could affect you even if you have been paying your debt on time. Because, if your credit rating gets you in a particular group of defaulters, the lender would classify your group as ‘high-risk’ and hike up the interest rates of all of the people in that specific group.
The hike in interest rate can be upsetting, even if you are not planning to borrow money anymore. According to the law, interest rates can only be increased if the lender provides a valid reason. The lender owes an explanation to the customer if the increment is based on the change in the risk-factor of the customer.
The Credit Card Providers’ Obligations
The credit card companies are liable to:
- Not increase the rate if you are facing debt problems, i.e., you have more than one repayment.
- Inform you regarding the increase in interest rate. Unless the interest rate is linked with the bank rate, the lenders are responsible for notifying you personally.
- Permit you to shut your account and pay the debt at the previous interest rate. For this, you would have to notify the bank within sixty days of increase. You can switch to a different credit card if you have a good credit score.
- Not to increase the interest rate within the first 12 months, and only increase it once every six months.