Credit Score Definition and How It Affects Your Loans

Credit Score Definition and How It Affects Your Loans

Even today, with all the information available on the Internet, on television and radio, there is still a good bit of misunderstanding regarding the difference between a credit report and a credit score. The two are interrelated, but it is still good to know a credit score definition and how it affects your loans.

Understanding Your Credit Score

Your credit score is actually based on the information contained in your credit report. While a credit report covers four main areas (identifying information, credit information, public records, recent inquiries), your credit score has five different categories which are weighed in varying degrees to come up with an overall score. In other words, a credit score is a combination of data which is then calculated to give you a score. The data considered when calculating your credit score is:

  • Payment history
  • Amounts Owed
  • Length of credit history
  • New Credit
  • Types of credit

However, each of those categories carries a different amount of weight when being factored into your credit score. The breakdown is as follows:

  • Payment history – 35%
  • Amounts Owed – 30%
  • Length of credit history – 15%
  • New Credit – 10%
  • Types of credit – 10%

As you can see, your payment history is the factor in determining your credit score. After that the amount of money you still owe weighs heavily on your score with the length of credit history, any new credit you have gotten and the types of credit in your history following last, almost equally weighted.

How Your Credit Score Affects Your Loans

One thing which isn’t always understood by consumers is the fact that lenders do not base their decision whether or not to lend you money based solely on your credit score. There are other things they take into consideration as well. However, it is imperative to have a good credit score if you want to get a loan or get a loan with decent rates.

In the United States, a credit score is often called your FICO, named after the Fair Isaac Corporation that was the originator of the system used to score creditworthiness. There are other types of credit scores out there, but FICO is by far and wide the most often scoring system used in the U.S. Scores range from 300 to 850 and the median in the U.S. is 723.

Anyone with a score at or below 600 would have an extremely difficult time getting a loan based solely on that credit score, and even then, rates would probably be sky high. FICO provides an example based on a 100 point difference in a credit score. They state that 100 points could mean you would pay as much as $40,000 more during the life of $300,000 mortgage loan. Think about that. That is a lot of money to be paying in extra interest because your credit score was 100 points lower than optimum.

In other words, those with less than perfect credit may still be able to qualify for a loan, but at what cost? Interest rates and finance charges work in counterpoint so that the lower your score goes, the higher interest you will pay, if you can qualify for a loan in the first place. The higher your credit score is, the lower interest rates you will likely be charged.

Keep in mind that lenders are reluctant to lend at the moment because the economy is on shaky ground. Now more than ever before it is vital to keep you credit score as high as possible by focusing on the factors which affect it. In a nutshell, your credit score affects whether or not you can get a loan and how much that loan will cost you.

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