Credit scores are designed to help lenders decide whether or not to approve certain loan applications and determine what loan terms to offer to which client. Credit scores are generated by algorithms that use information from your credit reports.
Banks and credit unions need to know how much at risk you might be at defaulting on your loan, so they look at your borrowing history for any clues. They want to know if you’ve borrowed any money before and have successfully repaid loans or if you have recently stopped making payments on any loans.
Types of Scores
There are multiple types of credit scores. Most refer to FICO credit scores, which are the standard, but you have a different FICO score for each of the three major credit types: Equifax, Experian, and TransUnion. When talking about your credit, it’s important to understand what type of score is being used. Traditionally, the FICO score is the most popular and is used for important loans such as home and auto loans.
Here’s how your score is calculated:
Payment history: Any missed payments or defaulted loans.
Current debt: What you owe, and are you maxed out on any credit cards.
Length of credit: Do you have a long history of borrowing and paying back.
New credit: Are there numerous loans in the recent past?
Types of credit: A healthy mix of different types of debt: auto, home, and more.
How much your credit scores are impacted by specific activities within the five categories mentioned isn’t easy to measure. Credit bureaus don’t reveal specifics, and if they did, the algorithm is complex with many combinations of factors that make it difficult to pin down a single credit score value for making a payment or even missing a payment.
Getting Approval on Loans
Credit scores do not alone determine your loan request approval. They are just numbers generated from your credit report and are a tool for lenders to use, setting standards for which credit scores are acceptable.
You can improve your credit scores by showing that you’re a seasoned, responsible borrower who is likely to repay on time. Build your scores with positive files, but that could take a bit of time.