When you have a poor credit rating, you probably know by now how hard it is to avail a personal loan. No matter which way you look at it, a poor credit rating is a liability you don’t want to be stuck with. If you want better loan terms and cheaper interest rates, there’s really only one thing you need to d and that is to work hard in improving your credit score.
What is a credit rating?
To effectively improve your credit score, it pays to understand what exactly a credit rating is. A credit rating is a financial concept used by lenders and financial institutions to determine a person’s ability to fulfill his or her financial obligations considering previous transactions and financial history.
Credit scores are in numerical forms. The FICO score, for example, has a range scoring from 301 to 850, which is then categorized into bad credit, poor credit, fair credit, good credit and excellent credit. The lower the number, the poorer your credit score is.
Understanding the Credit Score Formula
There are different elements that comprise your credit score. If we’re using the FICO formula, there are basically five categories you should know about and they include:
Payment history (35%) – A large part of your credit score is based on your payment history. This is why financial experts keep on reiterating the advice to always pay your bills on time. A number of missed or delayed payments can hurt your credit score. If you have debts that went into collection that will be another hit that can be hard to rectify.
Debt owed (30%) – The amount of debt you owe is another major consideration when calculating your credit score. If you have credit cards, how close are the charges to the credit limit? How much do you on personal loans? In general, the lower the debt you owe especially on your credit cards, the better for your score.
Credit history (15%) – There is no shortcuts when building your credit score. Another factor that affects your credit rating is the age of your credit history. Agencies look at past transactions and a number of credit references when formulating your score.
New credit (10%) – While only 10% of your credit score, new credit inquiries is another factor worth noting. Fortunately, this one you are entitled to some control. To avoid a lot of credit inquiries, you can check your own score for free and monitor it regularly too.
Types of credit (10%) – The more diverse your types of credit are, the better for your credit score it will be. It would really your score if you have a mix of different types of accounts like a major credit card in addition to a retail card.
Why it’s important to improve your credit rating?
Having a good credit score is what you should aspire to have if you want the best deals on your personal loans, mobile phone contracts and other financial offers or deals. Financial institutions tend to favor lending money to customers with good credit because there’s less risks involved.
Lenders are confident that customers with good credit can repay the loan or liability hence the lower interest rate. On one hand, customers with bad credit usually struggle to get approved for a personal loan because they are tagged as high risks borrowers. Most banks and major lenders are likely to reject your application if your credit rating does not meet their standard. In this case, you’ll be left with limited loan options. But worse of all, the interest rates will be steeper than if you have good credit.