What is Credit Scoring?

Credit scoring is a system used by creditors to determine the risk associated with granting a loan. In other words, this is an effort to measure the probability of getting back the disbursed credit. On the basis of this credit score a lender decides whether to entertain your application or not. Your credit report and credit application play vital role in credit scoring since information regarding your past credit experiences are collected to compute your score.

Following factors are considered while calculating your score:

Payment History – Most important credit scoring factor is payment history. It looks for your debt repayment habit and how much punctual you are with your payments. Questions like, if you were late with your payments in the past or not, how many late payments are there, did you take care of your default accounts by your own or it turned to collection, are raised here. It also keeps track of few public records like bankruptcy, judgment, foreclosure as these are closely related with your payment custom.

Debt to available credit ratio – Credit usage is another important aspect of credit scoring. Here the amount of your total credit limit is compared with your debt amount. This is important to decide if you are capable of handling more credit or not. If your debt amount is tending towards your credit limit, your score might slip down.

Age of your credit file – This is used to determine how long you have been using credit? Longer the period of your credit practice, greater is the chance of scoring high. It also checks how long you have used a particular credit account? It seems that senior citizens would beat youngsters at this point; however a young individual can obtain a high score if the other credit scoring aspects are adequate.

Recent application for more credit – Creditors are likely to run credit inquiries when you apply for a loan. These inquiries affect your credit scoring. Too many credit checks by potential lenders in a recent time can cause your score go down by few points.

Number and type of credit accounts (aka credit mix) – Number of accounts and variety of credit that you have been availing so far influence credit scoring. There is no one-word clue on how it is taken into account. It is assumed that a balanced state is preferred which means a good combination of different types of credit, like credit card, mortgage, student loan, auto loan etc, is considered to be positive.

Equal Credit Opportunity Act does not allow factors like race, sex, marital status, nationality or religion to be considered in credit scoring. Creditors may design a system that counts applicants’ age. However, it should offer unbiased service to elderly citizens. Personal information has nothing to do with credit scoring, though credit grantors often look for employment history as it is related with the risk involved in loaning you.

The creditor then uses a statistical program to compare this information with credit performance of past consumers having similar profiles. Points are awarded for each and every factor. The accumulated point is used to judge if one will pay back the loan amount or not. Apart from deciding whether a loan application is to be approved or not, lenders also use credit scoring to determine the credit limit and rate of interest.