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Credit Score and Its Importance

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The very first thing that your loan officer checks when you apply for a mortgage or any kind of credit is your credit score. You are rated in terms of the score which in most cases influences the amount you borrow. Understanding the credit score in a better way enhances your chances to develop a higher score and thus benefit from loans at better terms and conditions.

A credit score is that numerical quantity which makes all the difference in getting your loan approved by a mortgage lender or a car loan provider or even getting turned down for any kind of credit. Creditors use this score in finding out the risk in offering you the loan and your ability in paying it off. The better your score, the lesser is the risk involved

How the scores influence interest rates
Generally, credit scores range from 300 to 900 and an average score of 650 is rated as suitable for getting mortgages at reasonable rates and terms. It's your score that affects the interest rates on your home loan, insurance premiums and even the chances of getting a suitable employment.

The following table demonstrates how your score affects the interest rates and hence monthly payments required to pay off a 30 year fixed rate mortgage worth $210,000.

Credit Score
Interest Rate
Monthly Payment
760 - 850
6.3%
$1,330
700 - 759
6.5%
$1,360
680 - 699
6.7%
$1,390
660 - 679
6.9%
$1,420
640 - 659
7.3%
$1,500
620 - 639
7.89%
$1,600

Let us consider Mr. X having a score of 729 and qualifying for the 30 year fixed rate loan of $210,000 at 6.5%. He pays a monthly installment of $1,360. Another borrower, Mr. Y having a score of 685 gets the same loan amount from the same lender. But Mr. Y makes a higher monthly payment of $1,390 at a comparatively higher rate of 6.7%. The variation in the rates and payments is due to the difference in the scores of Mr. X and Mr. Y.

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Types of Credit Score
Such scores are of various types of which the FICO Score is the most popular one. It is calculated on the basis of the scoring model developed by the Fair Isaac and Company or FICO. The score is determined by evaluating the information available in the report. The FICO score is provided by all the three major reporting agencies

  • Experian: It is one of the 3 major credit reporting agencies that provide consumer credit information to businesses so that they can lend money to consumers.
  • Equifax: It is a major credit reporting agency in United States that gathers information from various sources and then compiles them in a report.
  • Trans Union: This is another major credit reporting agency in the United States. It provides personal credit information directly to consumers along with making credit reports available to potential creditors.

Apart from the FICO Score, there are alternative scores developed especially for consumers with poor credit. In general, all these scores are affected by factors such as your bill paying history, outstanding loan balance, the type of credit accounts maintained and others depending upon the type of the score.

Introducing a Unified Score
The FICO Scores offered by the credit reporting agencies vary from one another. This variation in the scores makes a difference in the interest rates charged on a certain loan amount. So all the agencies have developed a single scoring model based on which you can avail the same score from each of them. Thus, lenders can rate you in a consistent manner. Such a score is known as the Vantage Score and it will be introduced to consumers later this year although it is already made available to all businesses.



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