The current economic situation has made many consumers to become aware of credit. After all, you cannot turn on a TV, browse on the Internet or listen to the radio without hearing an advertisement about improving your credit. What is "improving your credit" and what is its significance? I am so glad you asked...
The definition of credit is listed below:
Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date.
Credit is one of the most important metrics used by banks to evaluate someone's ability to pay back a loan. How does this affect you? It basically works like this:
- You walk into the bank and ask for a loan.
- You will out the many applications they give you, one of the applications containing a release form that allows them to pull your credit score.
- The banks immediately receive a credit report with your credit score and hopefully the terms of the contract provided you the best interest rate possible for the loan.
Many people are pretty familiar with the credit application process, however it is a mystery as to how that credit score is determined. It breaks down into the following categories:
- Payment History (35%)
- Amounts Owed [Outstanding Debt] (30%)
- Length of Credit History (15%)
- New Credit (10%)
- Types of Credit Used (10%)
Payment History
This contains information about the delinquincies on your opened credit accounts. This can also be an indicator of any past bankruptcies. It also lists the time since the last delinquent account. Delinquent accounts definitely has a negative impact on your credit score.
Amounts Owed
This contains information about the proportion of money owed on outstanding debt. A large amount of outstanding debt will negatively impact your credit score.
Length of Credit History
This contains information about the time each account has been opened. This also contains information about the time of the latest activity on each account. Having a very short length of credit history will negatively impact your credit score.
New Credit
This contains information about recently opened accounts, credit inquiries and re-establishment of positive credit after prior delinquencies. Many credit inquires on your report will cause your credit score to be negatively impacted.
Types of Credit Used
This contains information about the different types of credit. Some of the credit types are mortgage, retail, credit cards, etc.
It is close to impossible to purchase a home, a car or even start a business without having a good credit score. In addition to that, even some employers will consider a person's credit score during their application process. Also, credit scores are used by landlords when choosing certain tenants to rent to.
From this article, I hope that you are able to better understand the different components that make up your credit score as well as the importance of keeping a good credit score. Stay Disciplined
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