What is credit?

Credit is the confidence in a borrower's ability and intention to repay. Credit is used with financial institutions, businesses, and in some cases individuals to obtain loans or lines of credit to purchase goods and services.

The credit a person has typically determines how much they will be permitted to borrow, for what purpose, for how long, and at what interest rates.

The level of "confidence" lenders have in potential borrowers depends on many factors:

1.    A person's income is an indicator of a person's ability to repay.

2.    The amount of debt they already have.

3.    The amount of borrowing a person has already done.

4.     How well they handled repayment on their loans or lines of credit.

5.     The length of credit history

Why use credit? 

The reasons for borrowing vary.  Loans and lines of credit allow borrowers to obtain goods and services, such as homes and automobiles, and enables borrower to repay over time. This makes large purchases more affordable. Most people could not afford to purchase homes or cars without the ability to borrow.

Understanding the scoring model

Your credit report details your credit history as it has been reported to the credit reporting agencies by lenders who have extended credit to you, by court records, collection agencies and by you personally.  The credit reporting agencies analyze information from the trade lines, inquiry, public records and collection sections of your credit report. They evaluate five categories in your credit report and compare them to consumers who have typical patterns in their past credit reports. The categories are as follows:

      1.    Types of credit in use — is it a good combination? 10% of the score

2.    Amounts owed — is it too much? 30% of the score

a.    Risk indicators analyzed:

                                          i.    Large outstanding balances

                                        ii.    The ratio of balances to credit limits

3.    Repayment history — do you pay your bills on time? 35 % of the score

a.    Risk indicators analyzed:

                                          i.    Severity – how bad are the delinquencies?

                                        ii.    Recently – how recent are they?

                                       iii.    Frequency – how many times did it occur?

4.    New credit — do you have to much debt? 10% of the score

a.    Risk indicators analyzed:

                                          i.    Number of inquiries and new account openings 

5.    Length of credit history — do you have established credit? 15% of the score

a.    Risk indicators analyzed:

                                          i.    Age of the trade lines - (the age of the oldest account, the average age of accounts, or both).

 

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