Part of your credit card or loan application will include the financial institution pulling your credit history. They may check your credit report, your credit score, or both, for two major reasons: for faster, unbiased application approval and to assign interest rates.
Creditors and lenders are in the business of loaning money. But, they can’t loan to everyone because not everyone can be trusted to repay.
You can’t tell by looking at someone whether they’re going to pay back what they’ve borrowed from you. And you certainly can’t judge simply by the information on an application. (Plus the Equal Credit Opportunity Act prevents creditors and lenders from discriminating against applicants based on physical features and other non-financial factors that do not indicate ability to repay.)
Banks need a way to objectively decide whether an applicant is likely to pay back what they’ve borrowed. That is, they need to make a decision that’s not based on feelings, opinions, or personal taste. That’s why credit reports and credit scores are so useful in lending decisions.
One of the ways a bank can decide if a person is likely to repay a loan is to look at how well they’ve paid loans in the past. It can reasonably be assumed that a person who’s met their financial obligations in the past will meet their financial obligations in the future. A credit report shows repayment history for a person’s past credit and loan accounts.
By reviewing an applicant’s credit report, the bank can better predict whether that person will pay back a new loan. For example, a history of timely payments would indicate an applicant who is likely to pay on time. On the other hand, lots of missed payments shows an applicant that’s likely to miss more payments.
Sometimes a person’s credit report contains several pages and dozens of accounts. It can be time-consuming to wade through each of those accounts to make a decision about an applicant. Furthermore, different people reviewing that same credit report may make different assumptions about any negative information. For instance, one person may see a 30-day late payment as indication that the applicant can’t be trusted to borrow money while another may be more lenient.
To make lending decisions even less subjective, many lenders use credit scores, either one developed by their own company or one developed by a third-party, like FICO or one of the credit bureaus. The credit-scoring model parses through the information in a person’s credit report and assigns a number, a credit score, to that credit report.
The developers of the model decide which credit scores are good and which are bad – that is, which credit scores indicate that borrowers are more likely to repay their debts. Credit scores give creditors and lenders an easier, faster, more reliable way of deciding who can be trusted with a credit card or loan and who can’t. Credit scoring models look only at credit report information (some in-house models may also consider income) to calculate their scores, so personal bias is completely removed and potentially discriminatory factors are excluded.
Credit reports and credit scores are also used to decide how much to lend and at what interest rate. Applicants who have more negative information on their credit reports, e.g. late payments and lots of debt, are presumed less likely to pay back their debts. So, when these applicants are approved, it’s often for lower amounts and at higher interest rates. Those with higher credit scores, on the other hand, will generally be approved for higher amounts and lower interest rates.
Creditor and lender use of credit reports and scores is one of the main reasons that it's important to achieve and maintain a good credit score. With a good credit score, you improve your chances of having your applications approved and will be given better interest rates.
Creditors and lenders are in the business of loaning money. But, they can’t loan to everyone because not everyone can be trusted to repay.
You can’t tell by looking at someone whether they’re going to pay back what they’ve borrowed from you. And you certainly can’t judge simply by the information on an application. (Plus the Equal Credit Opportunity Act prevents creditors and lenders from discriminating against applicants based on physical features and other non-financial factors that do not indicate ability to repay.)
Banks need a way to objectively decide whether an applicant is likely to pay back what they’ve borrowed. That is, they need to make a decision that’s not based on feelings, opinions, or personal taste. That’s why credit reports and credit scores are so useful in lending decisions.
One of the ways a bank can decide if a person is likely to repay a loan is to look at how well they’ve paid loans in the past. It can reasonably be assumed that a person who’s met their financial obligations in the past will meet their financial obligations in the future. A credit report shows repayment history for a person’s past credit and loan accounts.
By reviewing an applicant’s credit report, the bank can better predict whether that person will pay back a new loan. For example, a history of timely payments would indicate an applicant who is likely to pay on time. On the other hand, lots of missed payments shows an applicant that’s likely to miss more payments.
Sometimes a person’s credit report contains several pages and dozens of accounts. It can be time-consuming to wade through each of those accounts to make a decision about an applicant. Furthermore, different people reviewing that same credit report may make different assumptions about any negative information. For instance, one person may see a 30-day late payment as indication that the applicant can’t be trusted to borrow money while another may be more lenient.
To make lending decisions even less subjective, many lenders use credit scores, either one developed by their own company or one developed by a third-party, like FICO or one of the credit bureaus. The credit-scoring model parses through the information in a person’s credit report and assigns a number, a credit score, to that credit report.
The developers of the model decide which credit scores are good and which are bad – that is, which credit scores indicate that borrowers are more likely to repay their debts. Credit scores give creditors and lenders an easier, faster, more reliable way of deciding who can be trusted with a credit card or loan and who can’t. Credit scoring models look only at credit report information (some in-house models may also consider income) to calculate their scores, so personal bias is completely removed and potentially discriminatory factors are excluded.
Credit reports and credit scores are also used to decide how much to lend and at what interest rate. Applicants who have more negative information on their credit reports, e.g. late payments and lots of debt, are presumed less likely to pay back their debts. So, when these applicants are approved, it’s often for lower amounts and at higher interest rates. Those with higher credit scores, on the other hand, will generally be approved for higher amounts and lower interest rates.
Creditor and lender use of credit reports and scores is one of the main reasons that it's important to achieve and maintain a good credit score. With a good credit score, you improve your chances of having your applications approved and will be given better interest rates.
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