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What is a credit scoring system?
Lenders use a credit scoring system, or a numerical system, to measure how likely it is that a borrower will make payments on the money he or she borrows. It is created by assigning scores to various attributes associated with the applicant’s creditworthiness.
A credit scoring system allows lenders and other financial institutions to determine the creditworthiness of an individual. Some financial organizations establish their own credit scoring method.
Most will use a third-party professional service such as the Fair Isaac Corp.’s credit scoring system. This system, also known as FICO, is the most widely used model available. FICO’s scoring system assigns a numerical representation of creditworthiness that ranges from 300 to 850. The higher the number, the higher the individual’s credit score.
Many factors contribute to credit scores assigned through the systems. Factors include payment interest, length of time using credit, amount of debt a person has and the types of debt that person has.
Lenders use these methods to determine how much risk a particular borrower places on them if they decide to lend to that person. These figures are risk-based.
If an individual has a low credit score, he or she is likely to pay more to borrow money to buy a home or finance a car purchase than someone with a higher credit score. While credit scoring systems establish a guideline, individual lenders determine which level is acceptable and how much to charge in interest.
Credit scoring system example
Abby is 22 years old. She has one credit card she pays off on time every month. She has a car loan she makes monthly payments on as well. Based on her history of credit use, good repayment history and varied types of debt, Abby’s credit score is 710, using the FICO credit scoring system.
Learn how to improve your credit score to obtain a lower interest rate loan.