How Lenders Use Credit Scores

Introduction

So you are applying for a loan or refinancing your home. In addition to all the papers you have had to fill out, you also have to get a credit report. You may know what a credit report is, but you might not be aware how it can affect your loan. To understand this, you will need to know how a lender will use your credit scores to determine your creditworthiness.

Understanding Your Credit Score

Your credit score is a predictor of how high a risk you will be for a lender. A company that is considering extending credit to you will use credit scores and reports to determine any restrictions to your credit as well as your interest rate. For instance, if you have excellent credit, you are a very low risk and will not only get the loan but will get the best interest rate the lender can provide. If you are high risk, there is a good chance, according to statistics, that you will default on the loan. Even if you do get the loan, the lender will use your credit score to determine your interest rate, and you won’t like it. In essence, you will have to pay for the company to take a chance on you.

Where Do You Stand: Your Own Credit Score

So what are the limits in general? Well, the national mean credit score is about 723. This means that half of the population has scores below this number, and half has scores above. So if your score is around 720 or higher, you will probably qualify for the lowest interest rates. If it’s lower than 720, you will pay a higher rate depending on how far below this number your score falls.

Your Credit Score and Your Risk as a Borrower

Your lender will perceive your risk level this way due to the complicating factor of one other percentage, that of delinquency rates. Those with scores of 800 and above, the highest scores, only account for 11% of the population, and have only a 1% delinquency rate. This means that out of 100,000 people, 11,000 of them have scores this high but only 110 of them will end up with a late payment.

Specific Uses of Credit Scores By Lender

Lenders use credit scores for two primary reasons:

1. Lenders use credit scores to determine who they will lend to in the first instance.

2. Lenders use credit scores to determine what interest rate will attach to a particular loan. The better a person's credit score, the lower the interest rate.

Many People Have Credit Score Problems

While only 1% of the population falls into the lowest scores of 300-499, a huge 87% of those people will have delinquencies. Going back to our population of 100,000, this means only 1,000 people have that credit score. No biggie, you might think. But realize that 87% of them will actually have the delinquencies—that makes a total of 870 delinquent loans. If you were a lender, what would you do?

So make sure you don’t fall on the wrong side of the credit score bell curve. Lenders won’t like it, but you will like it much less.