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How does credit work?

How does credit work? 

Creditors have developed a safe system in which they make sure as to whom they lend money to. One way creditors or lenders check whether you are reliable, suitable, and efficient in paying back money is through your credit history or credit report. They determine through your borrowing and repaying funds record whether or not they will lend you money. Secondly, they check your credit score. Just because you had a good credit history, does not mean that recently that might be such a good one if your credit score has dropped. These scores are calculated by sophisticated systems, such as popular models like FICO® Score and VantageScore®, and although they calculate differently, they each assign higher scores to individuals whose credit histories have more creditworthiness statistically than those who have lower scores. 

What is a Credit Report?

Your credit history is collected in files and summarized into credit reports, which are compiled by three independent bureaus – Experian, TransUnion, and Equifax. These three bureaus receive your borrowing and repayment information from banks, credit unions, credit card issuers, and other creditors or lenders voluntarily. The information included in a credit report are: 

  • The number of credit cards and their borrowing limits and current outstanding balances.
  • The amounts of loans taken and how much were paid back. 
  • Information and records of payments, whether they were made on time, were late, or missed altogether.
  • More severe financial setbacks, such as mortgage foreclosures, car repossessions and bankruptcies. 

How is a Credit Report made, and who can see it? 

The three bureaus maintain and update millions of consumers’ credit reports, based on the information provided and supplied for by lenders and other creditors. Each file contains the relevance of a person’s history, borrowings and monthly payments. The credit report file also contains information such as your current name, and any other names one might have used in the past, current and past addresses and your date of birth. This is for verification purposes and to avoid identity theft. 

The credit file is updated with the latest information provided by the lenders, creditors, or other institutions. When your potential employer requests your credit report, the bureau provides the relevant contents of your credit file that are disclosable by law to the company, collecting and organizing it in a summary known as a credit report. 

Although the credit bureaus have your full payment history, they are authorized to only release records that are up to seven years old. Your credit report cannot be provided to just anyone; the types of companies that can check your credit and when they are allowed to do so will stumble on strict limits. 

Although creditors or lenders provide and supply information to the credit bureaus, they are not legally required to do so. 

Credit Scores 

In order for lenders or creditors to arrive to a conclusion as to whether they will give the loan to a person or not, they often use a three-digit number to calculate their risks, which is called a credit score. This is the first step lenders or creditors use in deciding whether they should approve a loan or not. Your credit score is a mirror reflection of your credit report, that interprets fairly your information, minimizing the possibility of bias. 

A credit score ranges between 300 and 850. A score of 300-579 is considered very poor, will not likely get you a loan approved, and even if it does, you will have high interest rates, as goes the same with 580-669, which is considered a fair score and an improvement, but still not good enough to get you lower interest rates. A good score is considered between the range of 670 and 739. A very good score of 740-799 gets you closer to your financial goals, 700 or above is generally good. What everyone strikes for, is the exceptional score between 800-850. This score will get you the lowest interest rates and a certain approval for a loan. 

A good credit score will help you purchase a home, buy or rent a car, an apartment, or if you are a student, help you refinance your student loans. You will get lower interest rates, saving thousand and thousands of dollars (perhaps hundreds of thousands), during a lifetime. A poor credit score will not guarantee you a loan, and in the case that it does, you will have higher interest rates, and in the long run it will cost you greatly.

FICO® Score and VantageScore® 

Different models calculate credit scores. The two most common are FICO® Score☉ and VantageScore®. 

What exactly is a FICO® Score? 

It is a credit score created by the Fair Isaac Corporation. Lenders or creditors use it to determine the approval of a loan and its risks. FICO Scores takes into account five areas to determine creditworthiness: payment history, current level of indebtedness, types of credit used, length of credit history, and new credit accounts. 

What exactly is a VantageScore®?

Developed by the three credit bureaus – Experian, TransUnion, and Equifax, VantageScore® is a credit score that is the most consistent, using only one model with one set of scoring calculations (unlike other scoring systems), resulting in scores that are more organized across all three bureaus. Easy in understanding the grading scale, VantageScore is regarded as the most accurate measurer of consumer creditworthiness, and the most predictive. You can understand easily how your credit is evaluated by lenders and the mystery out of credit scores and difficulties to understand it will be removed.