Your credit score is the primary criteria taken into account when determining your credit worthiness. Not everyone understands the loan process or how their credit score affects their chances of being approved for a loan. Your credit score is more than just a number; it is a reflection of you as a consumer. It simplifies into one word everything that is on your credit history.
While lenders will delve deeper into your credit report, your score will determine whether or not they are willing to take the time to investigate your history that deeply. If your credit score does not fit the lender’s criteria then they will not look far into your report.
This is why you must work hard to maintain your debts. All of the factors that go into determining your credit score should be properly managed to improve the likelihood of receiving an approval. They should also be controlled so you can attain a score high enough to provide you with the best loan repayment terms. These two issues – loan approvals and loan terms – are impacted heavily by your credit score and what you do to earn that score.
Higher Credit Scores = Lower Interest Rates
Usually. This will depend on the individual lender but, if you have worked hard to build your credit score up, then you will typically be rewarded with a lower interest rate on your loan. Not truly a reward, receiving a lower annual percentage rate (APR) is more of a business tactic. Lenders provide lower interest rates to higher credit scores as a way of enticing borrowers to use their services. If you are not offered a competitive rate then you are more likely to go through another lender for your funding needs. This prevents the lender from making money because they are not loaning you the money and earning extra revenue through the interest rate.
On Time Payments
To build your credit score up to the point you could be offered a competitively low APR, repay your debts on time. If you have credit cards, it is ideal for you to pay off the balances each month. If you are unable to pay it in full you must at least make the minimum payment to keep your account in good standing.
If you are repaying other, long-term monthly installments such as a mortgage or auto loan, you need to ensure you remain up-to-date with those installments. By missing a payment, you could be adding a negative item to your credit report, adversely affecting your credit score.
High Balances
Manage your spending. The use of credit in any form (loans, revolving lines of credit) is not only a good way of building your credit score, but it can help you in times of emergency or when you are faced with a need you just cannot pay for up front. However, maintaining your accounts with too high of a balance can negatively impact your credit score.
High Balances, especially for a lengthy period of time, will continue to keep your credit score lower than it could be. The average balance you want to maintain on any account is 30% of your credit limit. If you monitor your spending to keep your balances at this percentage, then you will be helping to raise your credit score or maintain it at a good level.
Credit Utilization Ratio
This ratio is the balance between the sum of all of your credit limits compared to the amount of credit you are using. As mentioned above, you want your individual accounts maintained at 30%, but your combined total of accounts should also remain no higher than the 30% mark. This will show that you are able to properly manage your spending as well as your repaying of the loans.
Indicator of Trustworthiness
Your credit score is a quick-glance evaluation of your credit worthiness. A lower score can indicate either you struggle to make payments on time or you have too many accounts and cannot support any more. Regardless of the reasoning for the late payments, the fact that they occur is a deterrent for loan providers. Your credit score is also a snapshot of the remaining four of the Five Cs lenders look at when deciding to finance a borrower.
Character
Your credit history is an overview of your character. As discussed above, the timeliness of your payments is an indicator of your character. If you fall behind on a payment or an account, then this could bring your score down a few points. If you fall behind on multiple accounts, then your credit score could suffer, reducing your chances of receiving the loan.
Capacity
This is your ability to repay the loan you are requesting. While one factor of capacity is having stable employment, this has more to do with your debt-to-income ratio. The amount of money you spend in a month to repay your debts, determined as a percentage of your monthly income, will help lenders decide whether or not they want to finance your needs.
Capital
Again, this is not necessarily how much money you have to repay the loan. Providing the lender with a down payment will show them two things: 1) your willingness and determination to receive the loan, and 2) that you have the ability to repay the debt. Giving the lender something up front will improve your chances of attaining the funding when combined with your credit score.
Collateral
The other option to providing a loan provider with good faith is to put something up for collateral. If your credit score is enough to qualify you for the loan then you may be asked to provide some form of personal property to secure the funds. If you are willing to provide your electronics, lawn equipment, car or boat, valuable jewelry or memorabilia, or any combination of property with a resale value, then your ability to obtain a loan will increase.
Conditions
What are the conditions to which you intend to use the loan? This is what you will be asked when requesting a loan. Many providers will require you to reveal what the loan will go towards. This will be as much of a deciding factor as the other Cs of Credit. If you do not have a good enough reason for requesting the money, then you are likely to be denied the loan. This is why you need to have a purpose for the loan – lenders are less likely to finance requests that are not well-thought beforehand.